This topic can be a very confusing discussion and sometimes it can be a subject of much debate and speculation. It is always important to note that the terms “employee” and “dependent” will be used and in some cases the lines between the two can be confusing.
Let’s begin by defining the term “employee” as it fits to the taxation of a business. For Federal tax purposes an employee is classified as a worker whom services are performed by and for your company. The employee’s services are directly controlled by you the employer at all times.
The term “dependent” can also have several different meanings as applicable to taxation; however for this discussion we will focus on dependents that meet the dependency test as your children.
When a child is employed by their parents, there are a few factors to consider:
- The child should be under age 18.
- The business is a Sole Proprietor or Partnership entity
The income paid to the child is not required to have Social Security and Medicare taxes applied to it. However, if the child is working in this same situations and the work performed is considered Domestic work in the parent’s home, then the age is up to 21 years old.
Please note that even though this income is not subject to the SS & Medicare, they are subject to federal income tax withholding, but not subject to FUTA (Federal Unemployment Tax) unless the payments are for domestic work. In both case the payments need to be under $50 in each quarter to qualify.
In the situation where the income for a child falls under the following:
- The entity is a corporation controlled by the parents
- The entity is a Partnership and a parent is a partner
- The entity is an Estate
In this instance the income is subject to Social Security, Medicare, FUTA, and income tax withholding rules.
Let’s have a couple of examples to clarify the scope of this. You have 2 children and you are both owners of Company A. MFG. Inc. in which you have hired your children of ages 17 (S) and 22 (D) to work last year. Child S was paid $2,500 for work performed and Child D was paid $15,000 for work performed.
Due to the fact that you are both owners of this company, the children are performing non domestic work; the income for Child S would be completely taxable in all tax tables. As for Child D, the income is also subject to taxation and you may want to review the dependency test for this child based upon the age and income earned.
You have a child whom is age 15, and you pay this child $45 to assist you with some work at home during summer break. You then, use the child to work with you on your normal business of an interior designer in which you are the sole owner of the business and it is not a corporation. The child works with you for the rest of the year and you pay $550 in wages.
In this case the wages are subject to Federal Income withholding only, due to the age of the child, amount, and the business entity. The $45 is not subject to any taxation at all.
Please review IRS Publication 15 Circular E and your State Department of Revenue for more details.