Tax Rules for Family Businesses

Peer Advice & Teaching Tips
Reading Time: 2 minutes

By: Annette Nellen, Co-Editor of the South-Western Federal Taxation series

 

It is not uncommon for a business owner to employ family members or to co-own the business with family members. For example, a sole proprietor accountant might hire her teenage son to help with data entry, website maintenance, and office cleaning. Spouses might co-own and operate a business. Tax rules often apply differently when family members are employees or co-owners of a business. For example, if the owner’s child under age 18 works for the parent, the wages are not subject to Social Security and Medicare taxes. Wages paid to a child under age 21 are not subject to FUTA.

Spouses who co-own a business have several options on entity type:

  • Partnership
  • S corporation
  • C corporation
  • Qualified joint venture

A qualified joint venture is basically a sole proprietorship but owned by both spouses. An election is required to be a qualified joint venture. Instead of filing a partnership return, the couple files two identical Schedule Cs that split the business revenue and expenses between the spouses (see § 761(f) and IRS website).

Also see IRS Fact Sheet 2019-14 (Oct 2019) on Tax treatment for family members working in the family business.

CLASS ASSIGNMENTS

  1. Ask students to research on the IRS website and RIA Checkpoint to find information on special tax rules involving family members as employees or co-owners. Also have them look at the website of their state tax agency to see if there is any information on this topic.
  2. Ask students why a qualified joint venture is more advantageous to both spouses than just having a sole proprietorship in one spouse’s name although both work in the business. For more information on this, see the IRS website.
  3. Ask students why Congress excused employer-parents from paying payroll taxes on their children-employees under age 18.
  4. Ask students what tax and non-tax advantages exist in employing one’s children in the family business.
  5. From a tax policy standpoint, what is the appropriate “taxing unit,” i.e., the individual, the family, a self-elected group of individuals? Explain your choice and tell why you rejected one of the other choices.
  6. Continue with your discussion in item 5. Now account for the debts of the taxing unit, i.e., who should bear the ultimate financial risks of the unit? Include Business Law concepts in your answer.

 

SWFT Chapters:

 

SWFT Individuals: Chapters 9 and 20

SWFT Corporations: Chapter 13

SWFT Comprehensive: Chapters 17, 18, 19, 20, 21, and 22

SWFT Essentials: Chapters 11, 12, 13, 14, 15, and 18

 

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