How to Pay Family Members in Your Business: A Tax-Smart Guide for 2025

Want to reduce your tax burden? Hiring family members in your small business could substantially lower what you owe.

Your child's wages remain completely exempt from Social Security and Medicare taxes if they work in your sole proprietorship or family partnership and are under 18 wages are completely exempt from Social Security and Medicare taxes. They won't pay any income tax when earning less than the standard deduction—$14,600 for 2024 and $15,000 for 2025. The benefits get better. Your child could earn up to $26,200 and pay just $1,160 in taxes at the 10% rate.

The tax advantages go beyond basic income benefits. To name just one example, children under 21 don't have to pay Federal Unemployment Tax (FUTA)[-3]. These tax rules create smart opportunities that help every family member involved in the business.

Your business structure determines which tax benefits apply when hiring family members. This piece walks you through the essential details about paying relatives while meeting IRS requirements for 2025.

Why Paying Family Members Can Be a Smart Tax Move

"One of the advantages of someone running their own business is hiring family members. But when including family members in business operations, certain tax treatments and employment tax rules apply." — Internal Revenue Service (IRS), United States federal tax authority

Hiring family members creates three major advantages for your business finances. You can fill vital roles and save money on taxes while keeping more earnings in your family.

Lower your taxable income through wage deductions

Paying family members in a small business lets you deduct their wages as business expenses. This reduces your business's taxable income and might lower your self-employment taxes. Your child's salary becomes tax-deductible if they do real work for your business, which turns higher-taxed business income into low or zero-taxed income.

Your spouse's employment opens doors to tax-advantaged benefits like health insurance or retirement plans. These benefits help your family and create additional tax deductions for your business.

Shift income to lower tax brackets

Family business tax planning works best when you move income strategically. Moving money from your high tax bracket to a family member's lower bracket helps distribute the tax burden better across your family.

This approach works great with children. Your child can earn up to the standard deduction ($14,600 in 2024 and $15,000 in 2025) without owing federal income tax. This creates a perfect scenario—your business deducts the wages while your child pays minimal or no tax on the income.

Here's a practical example: Paying two teenage children $14,600 each annually for legitimate work could move $29,200 of business income to them tax-free. This saves roughly $4,380 in income and self-employment taxes (at a 15% marginal tax rate).

Build retirement savings for family employees

Family employment opens doors to establish retirement accounts. Your child can contribute to a Roth IRA with earned income, and their money grows tax-free for decades.

Your spouse gets access to bigger retirement options. A SEP-IRA allows contributions up to 25% of compensation (maximum $70,000 in 2025). Another option is a SIMPLE IRA, which allows employee contributions up to $16,500 in 2025, plus employer matching contributions at 3% of annual salary.

These retirement plans offer immediate tax benefits while building long-term wealth for your family—making them perfect for family business tax planning.

IRS Rules You Must Follow When Hiring Family

The IRS examines family employment arrangements carefully and demands strict compliance with specific rules to qualify for tax benefits. You need to understand these regulations before you start paying family members in your small business.

Work must be real and age-appropriate

Family members must perform actual, legitimate work. The IRS warns against "ghost payroll schemes" where relatives receive paychecks without showing up or adding value. The Journal of Accountancy states clearly: "Hiring a relative is not an excuse to cut them a paycheck and not expect them to show up".

You should assign duties that match your family member's age and abilities:

• Young children: Modeling, simple filing, or organizing supplies
• Teenagers: Social media management, customer service, or office cleaning
• College-age: Bookkeeping, marketing, or running business errands

Note that child labor laws still apply despite family business exemptions. Federal law prohibits anyone under 14 from working except in specific exempt categories like acting or newspaper delivery.

Pay must be reasonable and industry-arranged

The compensation you offer must match industry standards and reflect the actual value of services provided. Under Tax Code §162(a)(1), business deductions for employee compensation are allowed only when "reasonable and paid for services actually rendered".

You should pay your family members what you would pay non-relatives to do the same work. The IRS immediately flags inflated wages for simple tasks. Tax experts emphasize that "just because your employee is related to you, that doesn't provide carte blanche to pay whatever you would like".

Avoid personal chores disguised as business tasks

The IRS makes a clear difference between legitimate business activities and personal tasks. You cannot repackage household chores, personal errands, and family responsibilities as business expenses.

Clear documentation will help you show how each family member's work directly benefits your business. This difference becomes especially important during audits, as family relationships need "close scrutiny" to determine whether payments were made for business or personal reasons.

By doing this, your family employment arrangement will give you tax advantages while staying compliant with IRS regulations.

How Business Structure Affects Tax Treatment

"Schedule C businesses are permitted to hire children under the age of 18, and the child's wages are exempt from Social Security, Medicare, and unemployment taxes." — U.S. Chamber of Commerce, Leading business advocacy organization in the United States

The way you structure your business substantially affects how the IRS handles wages paid to family members. Your entity type determines the tax implications, which could mean big savings or unexpected tax bills.

Sole proprietorships and family partnerships

Small businesses run as sole proprietorships and partnerships between parents get the best tax treatment when paying family members:

• Children under 18 are completely exempt from Social Security and Medicare taxes
• Children under 21 are exempt from Federal Unemployment Tax Act (FUTA) taxes
• All wages remain subject to income tax withholding whatever the age

These tax breaks create big savings that other business structures can't match. This special treatment works only for parent-child relationships in unincorporated businesses, which opens unique opportunities for family business tax planning.

Corporations and non-parent partnerships

Other business structures don't offer nearly the same tax benefits. Your business's incorporated status or partnership structure with non-parent partners means:

• All wages paid to children face income tax withholding, Social Security, Medicare, and FUTA taxes whatever their age
• Full taxation applies even when parents control the corporation

The same rules apply if your child works for a family partnership where someone other than their parents is a partner. Business structure alone creates this stark difference in tax treatment.

Impact on Social Security, Medicare, and FUTA

Family employment beyond parent-child relationships comes with its own tax rules:

Wages paid to your spouse typically face income tax withholding plus Social Security and Medicare taxes, but not FUTA. A parent working for their child must pay income tax withholding, Social Security, and Medicare taxes, but FUTA doesn't apply.

These specialized tax rules let you reduce your tax burden while providing income to family members. Your business structure plays a vital role in determining these family employment tax benefits, which makes choosing the right entity structure essential for family business tax planning.

Documentation and Compliance Essentials

Good documentation protects you during an IRS audit when you pay family members in your small business. Your family employment arrangement needs proper records to prove it's legitimate and not a tax avoidance scheme.

Track hours and tasks with timesheets

Every employee needs accurate timekeeping records, including your family members. The Fair Labor Standards Act (FLSA) tells you what information to track, but you can use any format:

• Employee's full name and social security number
• Address and zip code
• Hours worked each day and total hours weekly
• Wage rate and basis (hourly, weekly, etc.)
• Total earnings and deductions

Family members with fixed schedules can use a standard timesheet with checkmarks for normal hours. All the same, you must record the exact time worked when their hours change. This paperwork helps show that your family employees do real work.

Use W-4, I-9, and W-2 or 1099 forms correctly

Your family employees need the same tax documentation as other staff:

Each family member should complete a W-4 form to set up proper tax withholding. This form shows their filing status and allowances, which determine their tax withholding throughout the year.

You need to verify employment eligibility with Form I-9 to confirm identity and work authorization. Keep I-9s in a secure place separate from personnel files. You should store them at least one year after termination or three years from hire date, whichever takes longer.

Your family employees should receive W-2s by January 31 that show their annual wages and withheld taxes. Independent contractors get 1099 forms instead, but you must justify this classification.

Maintain contracts and payment records

The IRS wants you to keep employment tax records for at least four years, including:

• Your EIN and amounts of all wage payments
• Names, SSNs, and employment dates
• Copies of all W-4 forms and tax returns
• Records of tax deposits

We stored payroll records, collective bargaining agreements, and sales records for three years. It also helps to keep wage calculation records for two years, including timecards, work schedules, and records of wage changes.

Of course, formal job descriptions and employment contracts for your family members make your documentation stronger and establish the business nature of your arrangement.

Employing family members in your business provides significant tax benefits when done right. This piece showed you how family employment creates opportunities to reduce your taxable income, move earnings to lower tax brackets, and build retirement savings for your loved ones. Your business structure plays a crucial role here. Sole proprietorships and family partnerships make these benefits even better, particularly when you hire children under 18.

All the same, you must comply with regulations to get these tax advantages. The IRS looks for real work, fair compensation, and proper documentation. Your family employment arrangement could fail an audit without proper timesheets, tax forms, and employment records. A complete set of meticulous records protects you from IRS scrutiny.

These tax planning strategies provide a legal way to keep more money in your family while meeting your business needs. North Peak Finance experts can tailor these approaches to your specific business situation. They'll help you get the most tax benefits while staying compliant. Book your appointment today!

Tax planning in family businesses should balance immediate savings with building long-term wealth. Your business gets valuable work done while family members earn income, gain experience, and build tax-advantaged retirement savings. This creates immediate tax relief and sets up your family's financial success for generations.

FAQs

Q1. What are the tax benefits of hiring family members in my business?

Hiring family members can provide significant tax advantages, including lowering your taxable income through wage deductions, shifting income to lower tax brackets, and building retirement savings for family employees. For example, children under 18 working in a sole proprietorship or family partnership are exempt from Social Security and Medicare taxes.

Q2. Are there any special rules for paying my children in my business?

Yes, there are specific IRS rules to follow. The work must be real and age-appropriate, the pay must be reasonable and aligned with industry standards, and you should avoid disguising personal chores as business tasks. Additionally, children under 14 are generally prohibited from working except in specific exempt categories.

Q3. How does my business structure affect the tax treatment of family employees?

Your business structure significantly impacts tax treatment. Sole proprietorships and family partnerships offer the most favorable tax treatment, especially for children under 18. Corporations and partnerships with non-parent partners generally don't receive these special tax benefits and must pay all standard employment taxes.

Q4. What documentation do I need to maintain when employing family members?

Proper documentation is crucial. You should track hours and tasks with timesheets, use W-4, I-9, and W-2 or 1099 forms correctly, and maintain contracts and payment records. The IRS requires you to preserve employment tax records for at least four years, including payroll records, tax forms, and wage calculation records.

Q5. Can I contribute to retirement accounts for my family employees?

Yes, paying family members creates opportunities to establish retirement accounts. Children with earned income become eligible to contribute to a Roth IRA. For spouses, you can implement more substantial retirement options like SEP-IRAs or SIMPLE IRAs, which offer immediate tax advantages while building long-term wealth for your family.