Many business owners choose to hire family members to help with the business. They do this for any number of reasons. This can work very well if the family members are qualified and willing. Family members generally lower cost labor. I won’t get into all the potential pitfalls. I will discuss the tax implications of such labor choices.
One of the little-known tax issues is the status of the spouse. Under the Internal Revenue Code, spouses carrying on a business together that share in the profits and losses, they are generally considered partners. As such they must file IRS Form 1065. This is a must file return, whether they make any money or not.
Spouses may get around the 1065 by treating the business as a qualified joint venture. A business is a qualified joint when they meet three basic requirements. The first requirement is that the only members are a married couple filing a joint return. Note the two parts of the requirement. They must be married, not merely living together and they must file jointly.
The second requirement is that both spouses materially participate which means each spouse contributes in a positive way to improve the bottom line. The final requirement is that both spouses must elect not to be treated as a partnership. As a caveat, the qualified joint venture cannot be named as a state law entity. That means they cannot be a limited partnership or limited liability company.
Electing the qualified joint venture status requires each spouse to file a separate Schedule C to report profits and losses. No EIN is necessary unless otherwise required such as for employment taxes. If the venture obtains an EIN, it belongs to the business, not either spouse.
Many business owners choose to hire family members to help with the business. They do this for any number of reasons. This can work very well if the family members are qualified and willing. Family members generally lower cost labor. I won’t get into all the potential pitfalls. I will discuss the tax implications of such labor choices.
One of the little-known tax issues is the status of the spouse. Under the Internal Revenue Code, spouses carrying on a business together that share in the profits and losses, they are generally considered partners. As such they must file IRS Form 1065. This is a must file return, whether they make any money or not.
Spouses may get around the 1065 by treating the business as a qualified joint venture. A business is a qualified joint when they meet three basic requirements. The first requirement is that the only members are a married couple filing a joint return. Note the two parts of the requirement. They must be married, not merely living together and they must file jointly.
The second requirement is that both spouses materially participate which means each spouse contributes in a positive way to improve the bottom line. The final requirement is that both spouses must elect not to be treated as a partnership. As a caveat, the qualified joint venture cannot be named as a state law entity. That means they cannot be a limited partnership or limited liability company.
Electing the qualified joint venture status requires each spouse to file a separate Schedule C to report profits and losses. No EIN is necessary unless otherwise required such as for employment taxes. If the venture obtains an EIN, it belongs to the business, not either spouse.
Either spouse may report and pay the employment taxes as a sole proprietor. In some cases, this spouse may be considered a “successor employer” for FICA and federal unemployment wage base limits.
If a spouse works as an employee for the company, they are subject to normal withholding of any other employee with one difference. Federal Unemployment Tax Act (FUTA) contributions are computed based on the number of employees. The spouse acting as an employee is the exception to this rule. This does not generally represent a big tax savings, but it is a tax savings.
When children work for their parents’ sole proprietorship or parents’ partnership, the child employee under 18 is not subject to FICA and Medicare taxes. The child under 21 is not subject to FUTA. Income is subject to income tax withholding regardless of age.
If the business is a corporation or a partnership where there is a partner whom is not a parent, the child employee is just like any other employee. Withholding for FICA, Medicare and FUTA is due.
If the parent is the employee, and the child owns the business, the parent is subject to all withholding except FUTA calculations. If you are confused after reading this, you are not alone. The bottom line is this is a complex area of the tax code. Unless you really understand how to do this, hire a trusted professional