Family-owned businesses account for nearly 20% of small businesses in the United States. What’s more, these businesses are responsible for 78% of all new job creation and employ 60% of U.S. workers, making taxes related to running a family business a pertinent issue for many small business owners. If you’re running a family business, here are some tax-related tips you need to know to optimize your deductions, maximize your return, and reduce your risk of an audit.
What is considered a family business?
A business that has at least two family members — related by blood, marriage, or adoption — involved in its ownership and operation is considered a family business. However, there are other conditions that a family-owned business must meet regarding its organizational structure and governance.
To qualify as a family-owned business, a single family member must own a controlling stake in the company, have strategic decision-making power, and have control over the company’s voting system. Additionally, a family-owned business must include multiple generations of a single family and relatives from subsequent generations should be involved in managing the business.
In general, there are three types of family businesses:
- Family-owned businesses: These businesses are led by family members who have a majority of the ownership stake in the business.
- Family-managed and -owned businesses: One family member has a controlling stake and other family members determine the business’s policies and goals.
- Family-led and -owned businesses: One family member owns the business, while a different family member serves on the business’s board of directors in order to guide major decisions.
Taxes apply differently depending on your business entity
The IRS has different rules for family-run businesses depending on the type of entity your business operates as. Schedule C businesses, which include sole proprietorships, husband-wife partnerships, or LLCs treated as sole proprietorships for tax purposes, have different rules than S or C corporations.
Schedule C businesses are permitted to hire under-age-18 children with the child’s wages completely exempt from Social Security and Medicare (FICA) and Federal Unemployment Tax Act (FUTA) taxes. This exemption applies to both the employee’s share and the employer’s share of FICA taxes — a win-win for your business and your family.
If your business is incorporated, however, your child’s wages will be subject to FICA and FUTA taxes, just like those of any other employee.
[Read more: 4 Written Legal Agreements Every Family Business Needs]
Taxes apply differently to different relatives
Under IRS tax rules, there are differential treatments for relatives. Spouses are subject to different rules than children, and the regulations vary depending on the age of the children.
According to the IRS, if spouses operate a business together, sharing profits and losses, they may be regarded as partners regardless of whether they have a formal partnership agreement. As a single entity, the proprietor and their spouse are exempt from FUTA taxes, even though they are liable to income tax withholding and Social Security and Medicare taxes.
However, spouses may opt out of partnership in favor of a qualified joint venture. A couple may qualify if they are married and file a joint tax return and if both spouses contribute to the business. Both spouses must also agree to not be treated as a partnership.
When filing federal taxes, spouses who elect for qualified joint venture status are each considered sole proprietors and must report their profits and losses with individual Schedule C forms.
If one spouse is classified as an employee of the other spouse, then the employed spouse’s wages are subject to Medicare and Social Security taxes, as well as income tax withholding. However, the employed spouse’s wages are exempt from FUTA taxes.
When it comes to children employed by their parents, their tax statuses depend on their ages. If they are under 18 years old, they will not have to pay Social Security, Medicare, or FUTA taxes if their parents' business is a sole proprietorship or a partnership where both parents are partners. Children aged between 18 and 20 are given the same tax treatment as spouses and are only exempt from FUTA taxes. However, once they attain 21 years of age, they become liable to the same withholding taxes as any other employee, irrespective of their relationship with the employer.
Having strong documentation practices will make it easier to prove your tax returns are correct in the event of an audit.
The child’s wages are also subject to Medicare, Social Security, and FUTA taxes if the parent is in a business partnership with someone other than their spouse. Additionally, the child’s wages are subject to additional taxes if the family business is a corporation or the child works for an estate.
If a child employs their parent, the parent is liable to pay income tax withholding, Social Security, and Medicare taxes, but they are exempt from FUTA tax.
As for other family members — grandchildren, aunts, or nephews — their wages are subject to FICA and FUTA taxes like any other employee.
Take advantage of deductions in the Tax Cuts and Jobs Act
Before the Tax Cuts and Jobs Act (TCJA), a child employed at the family business was only able to take a standard deduction of up to $6,350. The TCJA doubled this provision through 2025 so that your child employee can shelter up to $13,850 of their annual wages.
As of the 2023 tax year, children aged 18 and younger can earn up to $13,850 before their wages are subject to federal income taxes unless they also earn income from other sources. A teenager who works part-time for their family’s business and earns $10,000, for example, can use the 2023 standard deduction to shelter their earnings from income taxes. This allows your child to utilize their earnings to support the family financially or invest in their future by depositing funds into a college savings account or contributing to a Roth IRA.
[Read more: The 3 Keys to Success (and Failure) in Family Businesses]
It’s also worth noting that a child who earns less than the standard deduction does not owe any federal income taxes. If your child is simply working a part-time job at your family business over the summer, it may be smart to ensure their wages fall under this $13,850 threshold as it relates to the child’s potential tax burden.
Protect your business and family from a potential IRS audit
Even though IRS audits are rare, you can protect your business and your family from a potential audit by maintaining accurate and thorough business records. Having strong documentation practices will make it easier to prove your tax returns are correct in the event of an audit.
Here are some tips to help your family business avoid a tax audit:
- Do not use rounded numbers in your tax returns. Consistently using rounded figures can indicate a lack of accuracy. Refrain from rounding a $47 expense up to $50, even if it makes your return easier to calculate.
- Double-check how your workers are classified. If your business hires independent contractors, make sure they’re qualified for that status. If they’re not, the IRS can classify them as employees, resulting in bills for back payments of payroll taxes.
- Ensure your deductions are accurate. There are specific guidelines when making deductions for home offices, work-related travel and meals, and charitable donations. Review any deductions you’re claiming to be sure they fit within the current IRS standards.
- Work with a tax professional or CPA. Working with an expert can ensure that your tax returns are neat, organized, and filed on time. A tax professional can also help you navigate the complex requirements for family-owned small businesses.
This story was originally written by Emily Heaslip.
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