In many closely held businesses, the owner’s spouse or children may help out by working in the business from time to time. For example, your spouse may pitch in during the “busy season” or your child may do odd jobs after school or during summer vacation.
Question: Does it make sense to put your spouse or child on your company’s official payroll (regular paychecks, tax withholding, W-2 forms, etc.)?
A “yes” answer comes quicker if you are self-employed and are hiring your child. Wages paid by a self-employed parent to a child under 18 are exempt from FICA (Social Security and Medicare) tax. If you are self-employed and employ your spouses, the wages you pay are subject to FICA tax.
If you operate your business as a corporation, there is no FICA exemption for children. Your corporation must withhold and pay FICA tax on all employees, including yourself, your spouse, and your children. So, in the case of corporate owners, the question becomes: If my spouse or child goes to work for my corporation, will there other tax savings that will more than offset the additional FICA tax?
Again, a “yes” answer is more likely if you are hiring your child. The wages your child receives are income tax deductible by your corporation and taxable to your child. But the corporation’s deduction may save it as much as 39 cents for each dollar of wages paid, while your child may owe little or no income tax on the wages. The standard deduction ($5,000 for 2005) can be used to offset your child’s taxable earnings. So, looking at the overall picture, the net income tax savings from hiring your child may well exceed the extra FICA taxes owned on his or her wages.
It’s a different story if you put your spouse on your corporation’s payroll. On a joint return, your spouse’s wages will be taxed on top of your income. The tax on your spouse’s earnings may equal or exceed the tax savings your corporation realizes on its deduction for your spouse’s wages. In other words, there may be a net overall income tax increase by putting your spouse on the payroll.
Of course, there are other factors to be taken into account if you are considering making your spouse or child a formal employee. For example, if you hire your spouse, you may qualify for a tax credit for any child care expenses you incur. Please contact us if you want to discuss whether family employment makes tax sense in your particular situation.
Special rules and regulations may apply when you hire young workers--whether they are your own children or someone else’s. For example, certain potentially hazardous jobs have been deemed off-limits for young workers, and working hours for young employees may be limited. We can assist you in complying with these special rules.