Family Businesses: Do You Know How to Navigate Taxes for Family who are Employees?
One of the advantages of running your own business is hiring family. But when including family members in a family business, certain tax treatments and employment tax rules apply. Here are some points to consider when working with a spouse, parent or child.
Both Spouses Working Together
If spouses run a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement, according to the IRS. Either way, they should report business income or losses on Form 1065 but not income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. But, the spouses can elect not to treat the joint venture as a partnership by making a qualified joint venture election.
Qualified Joint Venture
Spouses may elect to treat the family business as a qualified joint venture instead of a partnership. A qualified joint venture conducts a trade or business where:
- The only members are a married couple who files a joint return,
- Both spouses materially participate in the trade or business, and
- 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, such as a limited partnership or limited liability company, are eligible for the qualified joint venture election. However, in Louisiana, which is a community property state, it can still be disregarded.
Spouses electing this status are sole proprietors for federal tax purposes. Each spouse must file a separate Schedule C to report their share of profits and losses. They don’t need an EIN unless their sole proprietorship must file excise, employment, alcohol, tobacco or firearms returns. One spouse cannot continue to use the partnership’s Employer Identification Number (EIN) for the qualified joint venture. The EIN must stay with the partnership, as the partnership uses it for any year in which the business doesn’t meet qualified joint venture requirements.
Take note: once this election is made, it cannot be revoked without IRS consent.
If the business has employees, either spouse may report and pay the employment taxes as a sole proprietor. The spouse, as an employer, must have an EIN for their sole proprietorship. If the business 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 purposes of figuring whether wages reached the Social Security and federal unemployment wage base limits.
One Spouse Employed by Another
The wages for the services of an individual who works for their spouse are subject to income tax withholding and Social Security and Medicare taxes but not to the Federal Unemployment Tax Act (FUTA).
Child Employed by Parents
Payments to a child younger than 18 aren’t subject to Social Security and Medicare taxes if the family business is a sole proprietorship or a partnership in which each partner is a parent of the child. Payments to a child younger than 21 aren’t subject to FUTA.
All payments are subject to income tax withholding, regardless of the child’s age, as well as Social Security, Medicare and FUTA taxes if they work for:
- A corporation, even if it’s controlled by the child’s parent, or
- A partnership, even if the child’s parent is a partner, unless each partner is a parent of the child.
Parent Employed by Child
The wages for the services of a parent employed by their child are subject to income tax withholding and Social Security and Medicare taxes but not FUTA tax.
About Ericksen Krentel
Ericksen Krentel CPAs and Consultants, founded in New Orleans, Louisiana in 1960 with offices in New Orleans and Mandeville, believes that serving as the clients’ most trusted adviser is grounded in going beyond the numbers.
That includes helping clients achieve their business and personal financial goals by providing innovative and exceptional services in the following areas: audit and assurance services, tax compliance and planning, outsourced CFO services and business valuations for a variety of industries; employee benefit plan audits; fraud and forensic accounting; business planning; IT consulting; loss calculations; and estate planning.
Learn more at www.ericksenkrentel.com.