Hiring Family Members

Woman working with clay Family businesses have a better chance of surviving over the first five years than non-family businesses.  But working with family members can trigger emotional, legal, and business issues. Here are some things you should know about making your crafts business a successful family business.

Family members are easy to hire and hard to fire.  If you’re unsure about a family member’s skill sets, ask him or her to agree to work for a short specified period of time.  This can help to avoid painful termination if things don’t pan out during the trial period.

Family businesses affect the family’s bottom line. Don’t bring in a spouse  until you project the short-and long-term impact on your family balance sheet, especially if bringing in the spouse means losing other money-making (or money-saving) activities.

Be clear with directions and compensation. Accurately describe the work and spell out the type and variety of tasks. Compensation must be reasonable. If not, you’ll likely trigger resentment or disputes that will soon spill over to the dinner table.

Establish boundaries for family members. For most people, the boundary between work and family is clear, but that’s not always the case when a family member joins the business. “If you can’t turn it off at home,” says one business counselor, “your whole relationship rises and falls with the business.” One approach is to ban crafts business discussions during certain events, like dinner.

Take advantage of tax benefits when hiring kids. If you hire your children, you can deduct salaries you pay them. Your children, particularly those under age 18, probably pay taxes on this income at a lower tax rate than you pay on your business income (and they’re exempt from taxes on a certain amount of annual income). If your child is under 18, you don’t even need to pay payroll taxes—that is, payments such as FICA (Social Security and Medicare) and FUTA (federal unemployment) that are required for all other employees. Even more tax can be saved if the child establishes an IRA, the contributions for which are tax deductible up to a specified amount per year. For more information on employing your child, see IRS Publication 929, Tax Rules for Children and Dependents.  These rules don’t apply for hiring just anyone’s kids—only your own. If the IRS questions you, the primary concern will be whether the child does real work and is paid reasonable wages. In general, as long as you are paying for a task you would pay someone else to do—for example, sweeping up the studio, putting stamps on promotional postcards, running errands, entering data into a computer, or answering the phones—and as long as the payment is commensurate with what you might pay a non-family employee, the IRS will likely accept the categorization.

Hire Your Parents. If you hire your retired parents, you can deduct the expense, lowering your taxable income. Your parents will probably be taxed at a lower tax rate than what you pay. But before Mom and Dad punch the time clock, check what effect the extra income will have on their Social Security.  In some cases – for example, for parents under 66 – income they earn from your business could reduce their Social Security income.

Understand spousal co-ownership rules. If spouses own the business in a community property state (Arizona, California, Idaho, Nevada, New Mexico, Texas, Washington, or Wisconsin), they can report their business income on a Schedule C (as a sole proprietorship) as part of the joint return. This doesn’t save money but it does save the time and hassle of filing a K-1 partnership return, which is required of spouses who co-own a business in a non-community property state. If one spouse owns the business and the other works for it, however, it’s a sole proprietorship, and income is reported on the individual family member’s tax return.

Tread carefully with Family Limited Partnerships.  Chances are that you won’t need to think about family limited partnerships (FLPs)  for your family business because the tax benefits usually won’t kick in unless your family has millions in assets. In any case, the IRS is suspicious of FLPs.

Beware of divorce business-style. Even if only one spouse operates the business, the ownership will likely be split between both after divorce. Unless there is an agreement to the contrary—for example, a prenuptial or buyout agreement—divorce laws generally require that the value of the business ownership be split by the separating spouses. In community property states (Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin), each spouse is entitled to an equal share unless the business was acquired with one spouse’s separate property. In other states, a similar rule entitles each spouse to an equitable (fair) share of the business. Most ownership issues can be anticipated with a buyout agreement (also known as a buy-sell agreement). Buyout agreements are like a prenuptial agreement for your business. They can require that a person sell an ownership interest back to the company or to other co-owners, according to a valuation method provided in the agreement. Preparing the valuation can be tricky, which is why a buyout agreement can be helpful. It establishes a way to put a value on the business and usually requires that the value of the business be calculated on two dates: marriage and divorce. An attorney can assist in preparing a buyout agreement.

Incorporating the family business may save money at tax time. Incorporation has extra benefits when family members work in the business. If you incorporate the family business, you can shift income from higher tax brackets to lower ones (known as “income splitting”) by giving stock to family members in lower tax brackets—for example, giving stock to kids under age 14.