Hiring a family member: How to pay payroll tax

Payroll taxes and tax withholding generally apply to any family members hired by a business, but significant exceptions exist. This guide will help you understand how to pay payroll tax for family members your business hires.

How to pay payroll tax

Businesses must handle the following items for each employee unless an exception applies:

• Federal Income Tax withholding. Employees pay Federal Income Tax based on their income, including wages. However, companies must withhold part of each employee's wages and pay it to the IRS on their behalf based on the Form W-4 collected from each employee when hired.
• Social Security and Medicare (FICA) Tax. FICA Tax equals 15.3% of an employee's wages up to the contribution base, which changes annually. Employers must pay half of FICA tax—7.65%—while employees pay the other half. However, businesses must withhold and pay the employees' portion on their behalf.
• Additional Medicare Tax. Employees owe a 0.9% Additional Medicare Tax on wages that exceed a certain amount based on the employee's filing status. Companies must withhold 0.9% of wages over $200,000—regardless of the employee's filing status.
• Federal Unemployment (FUTA) Tax. Businesses must pay a 6% FUTA tax on the first $7,000 of wages paid to each employee.

Most companies report Federal Income Tax withholding, FICA Tax, and Additional Medicare Tax on Form 941 every quarter. Use Form 940 to report FUTA tax annually. Employers must also file Form W-2 to report wage, payroll tax, and tax withholding to employees and Form W-3 to report the information to the Social Security Administration.

Businesses must make all payments on the Electronic Federal Tax Payment Sys. (EFTPS) website. The IRS maintains an online guide for employment taxes.

State and local payroll taxes and tax withholding may also apply—requirements vary by jurisdiction.

Hiring your spouse or child

Certain payroll tax and tax withholding requirements don't apply to business owners hiring their spouses or children in specific circumstances. The exceptions below only apply to sole proprietorships, partnerships, and limited liability companies (LLCs) electing partnership tax treatment—not corporations or entities taxed as corporations.

The payroll tax and tax withholding treatment of your spouse depends on whether they own the business or merely work in it.

The IRS considers spouses who run a business together and share profits and losses to be partners even if they don't file a partnership agreement—though it's always best to have a written agreement. Spouses who wholly own a business, file a joint return and materially participate in the business may, in certain states, also choose qualified joint venture treatment instead of partnership treatment. This means each spouse would file Schedule C, Profit or Loss From Business, for their share as sole proprietors.

In either case, partners and sole proprietors take distributions, not salaries. Your spouse might owe self-employment tax based on their share of the business's income, but the business itself would avoid any payroll tax or withholding requirements.

FUTA tax does not apply to a spouse who merely works for your sole proprietorship, but all other payroll taxes and tax withholding requirements do.

Wages paid to your child under age 18 do not create any FICA tax, Additional Medicare Tax, or FUTA tax obligations as long as your business is a sole proprietorship or a partnership with no partners besides you and your spouse. Payments to your child over 18 but under 21 escape FUTA tax only. Federal income tax withholding requirements apply regardless. Make sure to actually treat your child as an employee, or the IRS may deny this tax benefit.

Paying payroll taxes on other family members

Your company must treat family members other than your spouse or child as ordinary employees for payroll tax and tax withholding purposes. However, wages paid to your parent do not generate FUTA tax.

Understanding how to pay payroll taxes and which exceptions apply to family members can help minimize payroll tax and tax withholding requirements for your family business.