Family members work with and for each other all of the time. If a family member is an IC under the tests discussed in this article, then that’s great—you don’t have to worry about such things as payroll taxes and unemployment compensation (depending on the test, of course). And even if the family member is your employee under these tests, you may still escape payroll taxes under special state rules. In Section 1, below, we discuss federal rules. In Section 2, below, we discuss state rules.
1. Federal Payroll Taxes
To determine if a family member is an IC for IRS purposes, follow the same steps that we describe in Chapter 4. If the family member is an IC, then you can stop there. If the family member is an employee, however, you may still escape federal payroll taxes (FICA and FUTA). Read on.
a. Children employed by parents
A parent need not pay FUTA taxes for services performed by a child who is younger than 21 years old. This is so regardless of the type of work the child does.
FICA taxes need not be paid for a child younger than 18 who works for a parent in a trade or business, or a partnership in which each partner is a parent of the child. If the services are for work other than a trade or business—such as domestic work in the parents’ home—the parent does not have to pay FICA taxes until the child reaches 21.
EXAMPLE: Lisa, age 16, works in a bakery owned by her mother and operated as a sole proprietorship. Although Lisa is an employee under the IRS test, her mother need not pay FUTA for Lisa until she reaches 21 and need not pay FICA taxes for her until she reaches 18.
However, these rules do not apply—and FICA and FUTA must be paid—if a child works for:
- a corporation, even if it is controlled by the child’s parent
- a partnership, even if the child’s parent is a partner, unless each partner is a parent of the child, or
- an estate, even if it is the estate of a deceased parent.
EXAMPLE: Ron works in a bicycle repair shop that is half owned by his mother and half owned by her partner, Ralph, who is no relation to the family. FICA and FUTA taxes must be paid for Ron because he is working for a partnership and not all the partners are his parents.
If a child is paid regular cash wages as an employee in a parent’s trade or business, he or she may be subject to federal income tax withholding regardless of age.
b. One spouse employed by another
If one spouse pays another wages to work in a trade or business, the payments are subject to FICA taxes and federal income tax withholding, but not to FUTA taxes.
EXAMPLE: Kay’s husband, Simon, is a lawyer with his own practice. Kay works as his secretary and is paid $1,500 per month. Simon must pay the employer’s share of FICA taxes for Kay and withhold employee FICA and federal income taxes from her pay.
However, neither FICA nor FUTA need be paid if the spouse performs services in other than a trade or business—for example, domestic service in the home.
EXAMPLE: Jill is a medical doctor with a busy practice. Her husband, Bob, stays home and takes care of the house and children. Jill gives Bob $1,000 a month as walking around money. These payments are not subject to any federal payroll taxes—FICA, FUTA or FITW.
But these rules do not apply—and FICA, FUTA and FITW must all be paid—if a spouse works for:
- a corporation, even if it is controlled by the individual’s spouse
- a partnership, even if the individual’s spouse is a partner, or
- an estate, even if it is the estate of a deceased spouse.
EXAMPLE: Laura’s husband, Rob, works as a draftsperson in Laura’s architectural firm. The firm is set up as a corporation solely owned and controlled by Laura. The corporation must pay FICA, FUTA and FITW for Rob.
c. Parent employed by child
The wages of a parent employed by a son or daughter in a trade or business are subject to income tax withholding and FICA taxes.
EXAMPLE: Don owns and operates a restaurant and employs Art, his father, as a part-time waiter. Since the restaurant is a business, Don must pay the employer’s share of FICA taxes for Art and withhold employee FICA and federal income taxes from his pay.
FICA taxes do not have to be paid if the parent’s services are not for a trade or business—for example, domestic services in the home. However, this rule is subject to one exception. Wages for domestic services by a parent for a child are subject to FICA taxes if:
- the parent cares for a grandchild (that is, the parent’s child’s child) who is either younger than 18 or requires adult supervision for at least four continuous weeks during a calendar quarter due to a mental or physical condition, and
- the parent’s child is a widow or widower, divorced, or married to a person who, because of a physical or mental condition, cannot care for the grandchild.
EXAMPLE: Sally is a divorcee with two small children who live with her. Sally works during the day so she hires Martha, her mother, to care for the children during working hours. Sally pays Martha $250 a week. Sally must pay the employer’s share of FICA taxes for Martha and withhold employee FICA and federal income taxes from her pay.
You do not have to pay FUTA taxes when you hire a parent to perform household services.
2. State Payroll Taxes
State payroll taxes consist of unemployment compensation which employers are required to pay directly to a state fund and state income tax that employers must withhold from employees’ paychecks.
a. Unemployment compensation
Every state except New York exempts from unemployment compensation coverage services performed by a person employed by his or her child or spouse. In New York, unemployment compensation must be paid where a child employs a parent.
All states except New Hampshire exclude from unemployment compensation coverage minor children employed by their parents. In over half the states, a minor child is one under 21 years old. In most of the other states, a minor is a child under 18. In Wyoming, the age is 19.
b. State income taxation
All states except Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming have income taxation. If a family member is an employee of your business and is paid regular wages, you may have to withhold state income taxes from his or her pay. Check with your state’s tax authority.
No income tax withholding is required for family members who qualify as ICs under your state’s income tax law.