Hiring family members in your small business can be a great way to share the workload and bring diverse skills to enrich your operation—you might even see some tax benefits. If you spend any time listening to tax advice on TikTok, it might seem like there are no downsides for small business owners.
However, it’s essential to understand the rules around hiring family members and choose wisely when deciding who will join you on your entrepreneurial journey. So let’s look at the potential benefits and pitfalls of having relatives working for or with you.
Benefits and Risks of Hiring Family Members in Your Business
There are several potential benefits to hiring family members in your business.
Trust and rapport
First and foremost, you likely have a degree of trust and rapport with your relatives that can be difficult to replicate with non-family employees. This can create a more cohesive and collaborative work environment and help ensure that everyone is invested in the business’s success.
However, hiring family members can also send the wrong signal to other employees. If other team members feel like family members receive preferential treatment, it can create resentment and tension among your non-family employees. This can lead to decreased morale and productivity and even increased turnover as employees feel undervalued and marginalized.
Save on self-employment taxes
From a financial perspective, hiring family members can also be advantageous. When you hire your child who’s under age 18, their earnings may not be considered employment for Social Security and Medicare taxes (FICA taxes) or Federal Unemployment Tax Act (FUTA tax), depending on your business structure. This allows you to shift some of your earnings to your child and reduce your self-employment tax burden. However, this is only the case if your business isn’t incorporated (S or C Corp) or a partnership that includes non-parent partners.
You can hire your child and pay them up to the standard deduction amount ($13,850 in 2023) per year tax-free. Assuming they don’t have any uneared income, such as interest, dividends, or capital gains that necessitates filing a return, they won’t pay any federal income taxes on the money, and they don’t even have to file a tax return.
Boost retirement savings
Another potential benefit of hiring family members in your business is the opportunity to boost retirement savings. This is particularly true when it comes to hiring your spouse. By having your spouse work for your business, you can contribute to two separate retirement accounts—your own and your spouse’s. Because employer contributions to the account are tax-deductible, you can potentially double your retirement savings while reducing your tax liability.
For example, if your company has a 401(k) in place and you meet certain requirements, your employee/spouse may participate in the plan. For 2023, you can each defer up to $22,500 of compensation to the plan ($30,000 each if you’re both 50 or older), plus any matching contributions from the company. Money in the accounts can grow on a tax-deferred basis until you start taking withdrawals.
Employing your spouse also has the potential to boost their future Social Security benefits. While non-working spouses already qualify for spousal benefits, those benefits are only 50% of the working spouse’s benefit amount. Putting your spouse on the company payroll allows them to have a Social Security earnings record of their own. However, if this is your primary reason for employing your spouse, it’s important to run the numbers to ensure the future benefits outweigh paying payroll taxes on their compensation.
If you hire your child, the earned income they receive from working in the business makes them eligible to contribute to an IRA. For 2023, you can contribute up to $6,500 to a Roth IRA on their behalf.
Hiring your spouse also allows you to pay them with tax-free benefits.
If you hire your spouse and pay them regular wages, there are no tax savings—you still have to pay the employee and employer share of payroll taxes. However, if you pay them entirely (or mostly) with tax-free fringe benefits, those benefits aren’t considered taxable income for your spouse and yet they’re fully deductible business expenses. You also don’t have to pay payroll taxes on the value of those benefits.
Tax-free fringe benefits include health, dental and vision insurance, up to $50,000 in life insurance, education expenses, and more.
However, if your business is structured as an LLC or a corporation, keep in mind that minimum wage laws apply, so you’ll have to pay your spouse at least minimum wage to avoid trouble with the Department of Labor.
Also, S Corporation owners can’t deduct fringe benefits like group term life insurance for any employee who owns 2% or more of the company—including coverage for an employee-spouse. The rules can get complicated, so be sure to discuss your situation with your tax professional.
Deductible business travel expenses
Normally, you can’t deduct travel expenses when a spouse accompanies you on a business trip. However, if your spouse is an employee and travels with you for business reasons, you can write off their travel expenses, including airfare, lodging, transportation, and 50% of business meals.
The same write-offs apply if your employee/spouse goes on a business trip alone.
Keep in mind that for any of the above benefits to apply, the family member has to be doing actual work for your business—the arrangement can’t just be on paper.
The work also needs to be age-appropriate if you hire your child. The IRS isn’t going to believe that your five-year-old provided $12,000 of consulting services to the business. So keep track of the hours and tasks they perform.
Hiring family members isn’t always the best move for your business—and it doesn’t always result in tax savings that make it worth it. Base your decision on whether the business actually needs their skills and talents, and let the financial benefits be ancillary.
If you’re considering hiring relatives but don’t know where to start, please reach out! We’re happy to help you decide whether mixing business and family makes sense.