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Tax Treatment for Family Members Working in the Family Business

 

What kind of business is a mom-and-pop operation? It's probably not a question you pondered when you dreamed of going into business with your spouse. If your spouse is integral to carrying on its operations and shares in the profits and losses, you may consider yourselves partners without the formal partnership agreement.

The IRS is interested in your business arrangements. The agency says that if your business is a partnership, your spouse should report income or loss from the business on Form 1065 instead of opting to report income on a Schedule C, naming you as the sole proprietor.

But both spouses may elect treatment as a qualified joint venture instead of a partnership. Your business is a qualified joint venture if it conducts a trade or business in which:

  • The only members are a married couple who file a joint return.
  • Both spouses materially participate in the trade or business.
  • Both spouses elect not to be treated as a partnership.

Only businesses owned and operated by spouses as co-owners and not in the name of a state law entity — limited partnership or limited liability company — are eligible for qualified joint venture status. Spouses electing qualified joint venture status are sole proprietors for federal tax purposes. Each spouse must file a separate Schedule C to report his or her share of profits and losses.

There's no need for an Employer Identification Number (EIN) unless the sole proprietorship must file excise, employment, alcohol, tobacco or firearms returns. But if you decide to designate the business as a qualified venture, one spouse cannot continue to use the partnership's EIN. The EIN must stay with the partnership; it's used by the partnership for any year in which the business doesn't meet qualified joint venture requirements.

If the business has employees, either of the spouses as sole proprietors may report and pay employment taxes. In that case, the spouse, as an employer, must have an EIN for the sole proprietorship. If the company filed or paid employment taxes for part of the year under the partnership's EIN, the spouse may be considered the employee's successor employer for the purposes of figuring whether wages reached the Social Security and federal unemployment wage base limits.

How about if one spouse is employed by the other? The wages for the services of an individual who works for a spouse are subject to income tax withholding as well as Social Security and Medicare taxes but not to the Federal Unemployment Tax Act (FUTA).

Suppose you employ a child. How is this handled so that you're in compliance with IRS rules and regulations? Payments for a child under age 18 aren't subject to Social Security or Medicare taxes if the business is a sole proprietorship or a partnership where both partners are the child's parents. Payments to a child under 21 aren't subject to FUTA. Payments are subject, however, to income tax withholding, regardless of your child's age.

Here are the circumstances under which you would have to withhold income taxes and Social Security, Medicare and FUTA taxes:

  • If the work is being done for a corporation, even if it's controlled by the worker's parents.
  • If the work is accomplished for a partnership, even if the child's parent is a partner, unless each partner is a parent of the child.

What if the parent is employed by the child? Wages for a parent are subject to income tax withholding as well as Social Security and Medicare taxes. But they're not subject to FUTA taxes.

Employees complete Form W-4 so that the employer can withhold the correct federal income tax from the pay.

There are no laws against nepotism in private business, but having family members work in your business presents some unique tax and employment situations.

 
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Siegel Solutions Inc
Siegel Solutions Inc
(781) 487-7000
info@siegelsolutions.com
144 Gould Street Suite 205
Needham, MA 02494
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Our firm provides the information in this e-newsletter for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided "as is," with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.
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