October 1, 2021
Paying Family Members Through Your S-Corporation
As the owner of an S-Corp, you have the option of having a family member work for you. There are a wide variety of advantages that come along with employing your spouse or child. But in order to maximize your savings, it's important to make sure the pros outweigh the cons.
When employing a family member, you must:
- Treat your employed family members the same as you treat other employees
- Have all employees submit a W-4 Employee’s "Withholding Certificate" to determine federal tax withholdings (most states have a similar form to help with determining state payroll withholdings)
- Pay family members that work overtime at the same rate as other employees (generally 1.5 times the base rate for more than 40 hours in a workweek)
- Give the same sick pay, holiday pay, vacation pay, and paid time off to all employees
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Hiring Your Spouse
As an S-Corp owner, you can elect to hire your spouse to perform certain duties for the company. Hiring and paying your spouse may increase potential fringe benefits and provide tax advantages.
Adding your spouse to the payroll could increase potential fringe benefits. A spouse on payroll will be paying into Social Security, which will increase the overall amount of Social Security benefits received during retirement. If you set up a 401(k) plan for your spouse, tax-free contributions will increase the overall family retirement fund. Other benefits include educational assistance, dependent-care assistance, compensation for sickness or injury, and business expense reimbursement through your Business Accountable Plan.
Wages paid to a spouse are not subject to Federal Unemployment Tax Act (FUTA) tax. FUTA tax is 6% on the first $7,000 paid to each employee in a calendar year. And many states exempt employed spouses from being subject to state unemployment insurance.
Hiring Your Parent
You have the option of hiring and paying one or both of your parents to perform certain duties for the company. Wages paid to your parent are exempt from FUTA tax as well.
Hiring Your Children
As an S-Corp owner, you have the option of hiring your children to perform various duties for the company, like handling the company’s social media accounts. Paying your children can decrease the family taxes, increase deductible business expenses, and help start a retirement plan for your children.
A Decrease in Overall Family Income Taxes
A family with a marginal tax rate of 37% that pays their 17-year-old child $12,400 a year, will see an overall tax savings of $4,399 or a net tax savings of $2,853 if the child is over 18. The child would pay 0% in federal taxes because the standard deduction (2020) would wipe out any federal tax liability. These tax savings drive an increase in business expenses and a reduction in reportable income on the parent’s tax return.
Various Savings of Employing your Child
There are other tax savings benefits that come along with employing your child. Most states exempt children employed by their parent’s business from unemployment insurance. And a child under 21 employed in a parent-owned business is not subject to FUTA tax. Single children over 25, in a lower tax bracket, may qualify for the Earned Income Credit, which would increase their overall tax refund.
ROTH IRA for your Children
Hiring and paying your children creates earned income for them, which means they qualify to contribute to a ROTH IRA. You can contribute the maximum amount each year, based on total income earned or $6,000, to your child’s account. While these contributions will not create a deductible business expense, they will allow you to help fund your child’s future. In addition to saving for retirement, they have the option of using the funds for education or the first-time purchase of a home. Contributions to a ROTH IRA will grow, tax-free, until your child is ready to retire. Someone who opens and funds a ROTH IRA at the age of 18 and contributes the maximum each year, could potentially have $1.74 million in their account when they are ready to retire at age 67.
Potential Complications to Employing your Children
The work your child performs must be bona-fide and age-appropriate. You cannot create “dummy” work to justify them being on the payroll. They must be paid a reasonable wage that would not be considered excessive for tax purposes. And the work must comply with the Federal Fair Labor Standards Act (FLSA) and state and local child labor laws. The FLSA provides guidelines for when and how long children can work and what types of tasks they can perform.
Family Employment & Your Tax Bill
Hiring your spouse, parent or child will increase the overall deductible expenses of the business since the wages, employer portion of payroll taxes, and the additional fees paid to a payroll service provider are all deductible. An increase in expenses will reduce the overall profit of the company. A reduction in the profit of the company will flow through as tax savings.
While hiring a spouse, parent, or child may have significant tax advantages, an increase in payroll will mean an increase in payroll processing fees, employer payroll taxes, and overall payroll expenses. You do not want to hire family members for perceived tax advantages if the overall cost of doing so exceeds the benefit. These tax savings will change if your business structure changes, as there are different rules for a partnership, sole proprietorship, or corporation when employing a family member.
Have questions about how to use family employment to save on your tax bill? Our team of experts are here to help.