Taxation rules for a Family Business

Kalpana Borjha | Kalinga University | 19th June 2020 

Introduction: 

A family business is a commercial organization where decision making is influenced by multiple generations of a family, who are related by blood or marriage or adoption. In simple terms, any business in which two or more family members are involved and the ownership and control of the business lies within the family is known as a Family Business. Usually, a self-employed business person hires his family member to work for the business.

Features of a Family Business:

• Family Business includes family members in business operations ensuring the effective utilization of capabilities in the family.
• Single-minded dedication of family members ensures the survival of the business through the toughest times.
• Family members as employees in the business are ideal as they are loyal to their work.
• The existence of a family business is determined by the understanding between the family members.
• Family members who do not contribute to the business are also a part of the business.
• A family business may also be comprised of more than one family in business operations.  

When family members are involved in the business, rules related to taxation and employment are required to be followed. Following are some of such tax treatments, which one must acknowledge to run a family business.

When both spouses are carrying on the business: When spouses carry on a business, they are considered as partners even if they do not have a formal partnership agreement between them. Being in the business together they share the profits and losses and should report the same to the income tax department. The spouses may choose not to treat it as a partnership and by making it a qualified joint venture.

Qualified joint venture: 

Both the spouse should materially participate in the business activities and should not be treated as a partnership. In this scenario, each spouse should file Schedule C separately to report their share of profit and losses in the business. Spouses elected for qualified joint venture status are considered as sole proprietors for federal tax purposes.

Employment Taxes: 

If a family business has employees, one of the spouses shall report and pay the employment tax as a sole proprietor of such business. If the spouse pays employment tax for part of the year under the partnership EIN, he/she will be considered as the ‘successor employer’.

• One spouse employed under the other: The income of a person who works under his/her spouse in a family business is subject to income tax and Social Security and Medicare Taxes.
• Child (Children) employed under parents: Income of a child is subject to income tax, irrespective of the child’s age. The income of a child under the age of 18 years isn’t subject to Social Security and Medicare Taxes and for those under 21 years, it isn’t a subject to FUTA.
• Parent employed under his/her Child: The payment of a parent who is employed under his or her child is subject to income tax withholding as well as Social Security and Medicare Taxes but not to FUTA tax.

Conclusion: 

Whatever the decisions the business family makes, they should not depend on taxation as a factor for their decisions. They must plan the business looking over the future aspects too. Early and informed planning is the best to ensure the business prospers over the years.