The tax rules for hiring family members turn almost entirely on how your business is organized. A sole proprietorship or a partnership owned only by both parents can pay a child under 18 without Social Security or Medicare tax, and can pay a child under 21 or a spouse without federal unemployment tax. A corporation, an S-corp, or a partnership with any non-parent partner gets none of that. Everything else — reasonable pay, hiring paperwork, wage-and-hour compliance, year-end reporting — applies the same way it would for any outside employee.
How Your Business Structure Decides the Tax Treatment
Under 26 U.S.C. § 3121, wages you pay your child under age 18 are exempt from Social Security and Medicare taxes when the business is a sole proprietorship or a partnership in which the only partners are the child’s parents.1Office of the Law Revision Counsel. 26 USC 3121 – Definitions That is the full 15.3% combined employer and employee share, and on a teenager’s wages it adds up quickly.
Federal unemployment tax has its own carve-out. Under 26 U.S.C. § 3306, wages paid to a child under 21 working for a parent, and wages paid to someone working for their spouse, son, or daughter, are excluded from FUTA entirely.2Office of the Law Revision Counsel. 26 USC 3306 – Definitions FUTA is normally 6% on the first $7,000 of each employee’s wages, with credits usually reducing the effective rate to 0.6%.3U.S. Department of Labor. Unemployment Insurance Tax Topic
These exemptions disappear the moment the business is a corporation (including an S-corp), a partnership with any non-parent partner, or an estate. In those cases the IRS treats every family member exactly like an unrelated employee, and all payroll taxes apply regardless of the worker’s age.4Internal Revenue Service. Family Employees Owners who convert a sole proprietorship to an LLC taxed as an S-corp for income tax reasons often lose the family payroll exemptions without realizing it.
Age Thresholds That Change the Answer
The FICA exemption for a child ends on the 18th birthday. The FUTA exemption lasts until age 21.1Office of the Law Revision Counsel. 26 USC 3121 – Definitions These are date-of-birth rules, not calendar-year rules. Start withholding and matching FICA the pay period after a child turns 18, and start paying FUTA after a child turns 21. Missing a transition triggers back taxes plus a failure-to-pay penalty that starts at 0.5% per month and can reach 25% of the unpaid amount.5Internal Revenue Service. Topic No. 653, IRS Notices and Bills, Penalties and Interest Charges
Spouses
Wages paid to a spouse working in a sole proprietorship are subject to Social Security and Medicare taxes but remain exempt from FUTA.2Office of the Law Revision Counsel. 26 USC 3306 – Definitions6Internal Revenue Service. Topic No. 751, Social Security and Medicare Withholding Rates A spouse’s earnings do build Social Security credits, which can matter if the spouse doesn’t otherwise have a sufficient earnings record.
Reasonable Pay and Real Work
Every dollar you pay a family employee has to clear two hurdles to be deductible: the work must actually be performed, and the pay must be reasonable for the job. Under 26 U.S.C. § 162, a business can deduct compensation only when it represents “a reasonable allowance for salaries or other compensation for personal services actually rendered.”7Office of the Law Revision Counsel. 26 USC 162 – Trade or Business Expenses Family hires draw more scrutiny here than any other kind.
Pay a 14-year-old $50 an hour to file papers and an auditor will compare that rate to what you’d pay a stranger. The IRS looks at what similar businesses pay for comparable work, the employee’s qualifications and experience, and the hours actually worked.8Internal Revenue Service. Paying Yourself Public salary databases and local job listings are the easiest way to set a defensible rate. Overpaying a relative doesn’t just risk the deduction; the IRS can reclassify the excess as a gift or a distribution, which changes the tax treatment on both sides.
Keep records. Document the job description, hours worked each week, tasks completed, and how you arrived at the pay rate. Time sheets, comparable job postings, and a written employment agreement all serve as evidence that the arrangement is legitimate.
What the Child Gains From Real Earned Income
Paying a child for real work creates earned income in their hands, which unlocks two useful benefits.
The Child’s Standard Deduction
A dependent child with earned income gets a standard deduction equal to the greater of $1,350 or earned income plus $450, up to the full single-filer standard deduction.9Internal Revenue Service. Topic No. 551, Standard Deduction In practice, a child earning $14,600 or less in 2025 owes no federal income tax. Combine that with the FICA exemption for a child under 18 in a sole proprietorship and a meaningful amount of family income can move to the child at essentially no current tax.
Roth IRA Contributions
Earned income also makes a child eligible for a Roth IRA. For 2026, the annual contribution limit is $7,500 or the child’s total earned income, whichever is less.10Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026, IRA Limit Increases to $7,500 A parent can fund the contribution as a gift; the child only needs to have earned that much during the year. Decades of tax-free growth from age 14 or 15 is one of the strongest long-term payoffs available inside a family business.
Wage and Hour Rules Still Apply
Federal child labor rules relax for parent-owned businesses, but wage-and-hour obligations do not disappear. Children under 16 working in a non-agricultural business solely owned by their parents can work any hours, at any time, in any non-hazardous occupation. The hazardous occupation ban is absolute regardless of family relationship. On a farm the parent owns or operates, a child of any age can work in any occupation at any time.11U.S. Department of Labor. FLSA – Child Labor Rules Advisor – Exemptions from Child Labor Rules in Non-Agriculture
Family employees are generally entitled to the federal minimum wage of $7.25 per hour and overtime at one-and-a-half times their regular rate for hours over 40 in a workweek.12U.S. Department of Labor. Wages and the Fair Labor Standards Act Many states set higher minimums, and the higher rate wins. The family relationship creates no exemption.
A family member can be exempt from minimum wage and overtime only by qualifying as an executive, administrative, or professional employee. Following the vacatur of the 2024 rule by a federal district court, the Department of Labor is currently enforcing the 2019 threshold: a minimum salary of $684 per week ($35,568 annually) plus job duties that involve actual management or professional work.13U.S. Department of Labor. Earnings Thresholds for the Executive, Administrative, and Professional Exemption A title alone does not satisfy the duties test. If the DOL investigates and finds underpayment, liquidated damages can double the amount owed.
Hiring Paperwork You Still Have to Do
Family members need every piece of hiring paperwork that a stranger would. Skipping documentation because it’s “just my daughter” is what unravels the arrangement in an audit.
Form I-9
Every new hire in the United States must complete Form I-9, Employment Eligibility Verification, regardless of citizenship status or relationship to the employer.14U.S. Citizenship and Immigration Services. 2.0 Who Must Complete Form I-9 Examine original identity and work authorization documents within three business days of the hire date.15U.S. Citizenship and Immigration Services. Handbook for Employers M-274 – 14.0 Some Questions You May Have About Form I-9 Keep the completed form for three years after hire or one year after employment ends, whichever is later.16U.S. Citizenship and Immigration Services. 10.0 Retaining Form I-9
Form W-4
The family employee completes a Form W-4 so you can determine federal income tax withholding.17Internal Revenue Service. About Form W-4, Employee’s Withholding Certificate Even when wages fall below the filing threshold and no withholding is due, a completed W-4 on file shows you followed procedure. If the child claims exempt, you still report the wages on the year-end W-2.
New Hire Reporting
Federal law requires employers to report every new hire to a state directory within 20 days of the start date.18Administration for Children and Families. New Hire Reporting That includes a spouse or child. Some states require reporting sooner, so check with your state labor department.
Payroll Filings and W-2 Reporting
Reporting obligations survive even when most payroll taxes are exempt. Consistent reporting is what separates a legitimate family employment arrangement from something the IRS may recharacterize as a disguised gift or income shift.
Most employers file Form 941 each quarter to report income tax withheld and Social Security and Medicare taxes. If total annual employment tax liability is $1,000 or less — common when the only employee is a child exempt from FICA — you can request permission to file Form 944 once a year instead.19Internal Revenue Service. 2025 Instructions for Form 944 – Employer’s ANNUAL Federal Tax Return Businesses paying $5,000 or less in total wages will generally fall under the $1,000 liability threshold. You must contact the IRS to make the switch; you cannot decide unilaterally.
At year-end, issue a W-2 to every family employee showing total wages paid and taxes withheld, even where those amounts are zero. File copies with the Social Security Administration on the same schedule as any other employee. The W-2 is the document that proves the child had earned income for the standard deduction and Roth IRA purposes described above, so accuracy here directly supports the tax planning.
State Rules Do Not Follow the Federal Exemptions
Federal tax exemptions and state insurance requirements don’t line up.
State Unemployment Insurance
State unemployment programs set their own rules on family coverage. A child exempt from federal FUTA may still generate a state unemployment obligation. State taxable wage bases and contribution rates vary widely, and rates depend on your experience rating. Check with your state labor department before assuming the federal exemption means zero unemployment cost.
Workers’ Compensation
Workers’ compensation is state law, and many states exclude a spouse or child from mandatory coverage in small family operations. Thresholds vary; some states require coverage from the first employee, others exempt businesses below a headcount. The family exclusion typically covers only immediate relatives of the owner and evaporates once you hire an unrelated worker. A workplace injury to an uncovered family member creates the same medical costs and potential liability as an injury to a stranger.
FUTA Credit Reductions
For family employees who are subject to FUTA (children 21 and older, or employees of a family-owned corporation), the standard 5.4% credit against the 6% FUTA rate is not guaranteed in every state. States that borrowed from the federal unemployment trust fund and haven’t repaid face credit reductions that raise your effective FUTA rate. For 2025, employers in California faced a 1.2% credit reduction, pushing the effective rate above the typical 0.6%.20Federal Register. Notice of the Federal Unemployment Tax Act (FUTA) Credit Reductions Applicable for 2025 The list changes annually.
Retirement Plan Attribution Rules
If your business sponsors a 401(k) or other qualified retirement plan, family hires bring attribution rules that complicate nondiscrimination testing. The IRS treats certain family members’ ownership as if it belongs to the employee for purposes of identifying highly compensated employees and key employees. A spouse’s ownership is automatically attributed to the employee, and a parent’s ownership is attributed to their children and back again under IRC § 318.
The practical result is that a 19-year-old working part-time in your business is not a rank-and-file employee for testing; they are treated as owning the same stake you do. That can make them a highly compensated or key employee, which affects whether the plan passes coverage and contribution tests. A failed test puts the plan’s tax benefits at risk for everyone in it. Work with a plan administrator who understands attribution before you make contributions, not after the testing deadline.