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There are benefits to hiring family members to work in your sole proprietor business and many daycare providers take advantage of this. If your children are under the age of 18, you are not required to withhold social security and Medicare taxes from their wages. You are also not required to pay federal unemployment taxes (FUTA) on their wages until they reach the age of 21. Spouse and parent employees are also exempt from FUTA, but you must withhold social security and Medicare taxes.
You do have to follow the normal payroll rules, file payroll tax returns and withhold income tax. And you must prepare a Form W-2 for your family employee at the end of the year.
On the other hand, if your relative works for you on a limited basis, you might not want to hire them at all. You can consider Tom Copeland's suggestion to gift them some money instead. If you go this route, however, you cannot deduct the cost as a business expense for income tax purposes.
Only self-employed business owners can take advantage of the special rules for family employees. Partnerships qualify, as long as the parents are the only partners. If your business is incorporated, the family workers are considered employees of the corporation, and are subject to the normal payroll taxes regardless of their age.
Remember that when hiring your own children, you can pay them to do work for your business, but you cannot pay them to do personal household chores.
In California, family employees (children under 18, spouses, parents, and domestic partners) are exempt from paying state disability insurance (SDI) and you, as the employer, are exempt from paying state unemployment insurance (UI) and the employer training tax (ETT). See the Employment Development Department's Family Employment Information Sheet for further information.
Read my Payroll Tax Guide to learn more about employment taxes.
Last updated 16 June 2012