As a CPA in the great basin area, one question that I am commonly asked about, is how hiring a family member works. Are there benefits to hiring family? What are the drawbacks?
Hiring Your Spouse
I want to start out by saying that if it is a small business environment, a spouse hiring another spouse, is not a good idea. For this type of situation, self-employment taxes apply to both the husband and the wife. Because of this, it is probably not in your best financial interests. However, if one spouse needs more social security credits to be able to get social security, this is a good idea.
Hiring Your Children
When it comes to employing family members, the most common situation involves your children. The thing that you need to think about is how it will affect your tax bracket and other deductions. An experienced CPA will be able to help you determine if hiring your children is a good idea.
Take for example the employing of Tom and Sally. If I am the owner of an S corporation and I hire my two kids some good and bad things can happen. Pretend that I am in the 35% tax bracket and they are in the 0% tax bracket. Their standard deduction for earned income for 2009 and 2010 is $5700. Therefore, I can pay Tom and Sally up to $5700 and I will get a deduction for it on the S corporation side, which means I save myself 35% of that $5700 times two. Furthermore, they will not have to pay any taxes because they did not make enough.
The bad news is that they will owe payroll tax on their earnings. Therefore, 6.2% for social security, 1.45% for Medicare will be taken out. If I am paying them $5700, they end up paying $436 and I pay the other half.
Now if we look at any business that is not a corporation things change a bit. I could pay the kids $5700 each and they will be exempt from federal income tax withholding. In addition, I would save that $900 that I would have had to pay towards social security and Medicare. Due to the added savings, I highly recommend paying your children through a non-corporate business.
Be Careful For Extra Pay
Because they are your children, you may feel obligated to pay them a little bit more than your other employees. You need to remember that as their income increases, so do their taxes. Also, if you are audited you need to be able to justify why you were paying your child what you were. If you paid them a total of $14,000, you need to be able to break it into an hourly pay and explain why you paid them what you did. I had one case where a child was getting $7,000 a year for cleaning the office and shredding paper, which is fine. However, the child was three, so it is hard to justify paying a child that much.
If you are thinking about employing a family member, you need to talk to a CPA. There are many deductions and benefits to hiring your family members, but you need to be careful so that it does not come back to bite in the end.