How To: Hire Relatives for Your Business

What we’ll cover:

• Why Hiring Relatives Makes Sense
• How to Set Up the Relationship Properly
• Tax Considerations for W-2 Employees vs 1099 Contractors
• Compliance Essentials
• Key Tips for Managing Risks
• Frequently Asked Questions

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1. Why Hiring Relatives Makes Sense

Tax savings for you, tax-free earnings for your relatives

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• Amounts paid to your family for their work in your business are deductible business expenses that can reduce your taxable income.
• If you're paying a child who's total income is below the standard deduction ($14,600 in 2024), they will pay no federal income tax. Win-win!

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Example: By hiring your child and paying them $14,600 from your business in 2024, you could potentially save over $5,000 (depending on your marginal tax rate), and they could pay no tax on the amount you paid them

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Income shifting to a lower tax bracket

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If you're paying someone who's total income is in a lower tax bracket than yours, shifting income to them may allow you to reduce your family’s overall tax liabilities.

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Early retirement savings

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Having earned income enables your relatives to contribute to accounts like a Roth IRA, setting the stage early for long-term growth.

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2. How to Set Up the Relationship Properly

Define the relationship

You need to determine if you are hiring someone as an employee, or an independent contractor:

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• A W-2 employee is ideal for roles that demand control over how the work is performed.
• A 1099 contractor is suitable for independent workers handling specific tasks at their discretion.

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Misclassification of employees as contractors can result in fines.

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Read more on this topic from the IRS here.

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Document the relationship

• Draft an employment or contractor agreement that specifies the job role, responsibilities, and pay structure.
• Assign clear and specific responsibilities to ensure the work is legitimate and measurable.
• If paid hourly, maintain a system for time tracking to document hours worked.

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Stay compliant with labor laws

• Ensure adherence to federal and state labor regulations, including minimum wage and child labor laws.
• Consider consulting an employment attorney to help establish or maintain compliance.

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3. Tax Considerations for W-2 Employees vs 1099 Contractors

If your relative will be paid as an employee:

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• Use a payroll system to issue paychecks and coordinate your required payroll tax filings.
• Ensure payroll expenses are properly recorded and reconciled in your accounting records.
• File a W-2 for each employee by January 31 of the following year. Your payroll processor should handle this.

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If your relative will be paid as an independent contractor:

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• Arrange payments based on the terms of your contractor agreement.
• Issue a 1099-NEC if total payments exceed $600 annually. Ensure this is done by January 31 of the following year.

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4. Compliance Essentials

Legitimacy of work

• The work performed must be justifiable as an ordinary and necessary business expense. Fraudulent arrangements can lead to penalties and IRS scrutiny.
• Ensure responsibilities are clearly defined and documented to validate your hiring decisions.

Dependent status

Be mindful of how your relative’s earnings might affect their dependency status and your eligibility for certain tax credits.

FICA tax exemptions

If your business is a sole proprietorship, wages paid to children under 18 may be exempt from FICA (social security and medicare) taxes.

Administrative costs

Be aware of additional expenses such as:

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• Issuing payroll or 1099 forms
• FICA (social security and medicare) and unemployment taxes, unless you qualify for an exemption
• Filing a separate tax return to report your relative’s income, if they aren’t otherwise required to file.

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Estimated costs are around $1,000 annually, depending on your service providers and pre-existing compliance requirements.

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5. Key Tips for Managing Risks

Document everything

From agreements to pay records, maintain detailed documentation to establish that the arrangement is legitimate.

Monitor full-time eligibility

Hiring a relative for more than 1,000 hours annually might disqualify your business from Solo 401(k) contributions - be careful to avoid unintended consequences.

Check state-specific rules

Catch up on state labor laws to address unique wage and hour requirements.

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Frequently Asked Questions

Q: Can I hire my child if they are under 18?

Yes, but ensure the tasks are age-appropriate and follow child labor laws. Wages paid to children under 18 by sole proprietors may qualify for FICA tax exemptions.

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Q: Do I need a written agreement?

It’s highly recommended. Formal agreements help define roles, responsibilities, and expectations, which is critical for legitimacy and compliance.

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Q: Can I still claim my relative as a dependent if they work for me?

It depends. If their total income exceeds a certain threshold or they provide more than half of their own financial support, they may no longer qualify as a dependent.

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ℹ️ This guide is designed to help you navigate the complexities of hiring relatives while maximizing tax benefits. This information is for educational purposes only and does not constitute legal or tax advice.

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References

FICA Tax Exemptions for Minors: In certain situations, wages paid to your children under 18 may be exempt from FICA taxes. Refer to the IRS page on Family Employees for specifics.

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Dependent Status: If the relative earns sufficient income, they may no longer qualify as a dependent, affecting tax credits or exemptions. Review IRS Publication 501 for details on Dependents, Standard Deduction, and Filing Information.