Summary of What This Blog Covers:
- IRS rules for paying family through your business
- Risks of informal payments and lost deductions
- How business structure impacts tax treatment
- Strategies to stay compliant and maximize benefits
Let’s set the stage: You’re a business owner with a sharp eye, a clear vision, and an ever-growing to-do list. You’re building something real and fast. So when your spouse offers to help with billing or your teenager’s suddenly a whiz at Instagram, it makes perfect sense to put them on the payroll. They get experience and a paycheck; you get help and a tax deduction.
Smart, right?
It can be. But only if you do it right. Because while it feels personal, the IRS sees payroll through one lens: compliance. And your well-meaning family hire could turn into an expensive tax problem if you don’t know the rules of the game.
So here it is, your entrepreneur’s guide to paying family through your business. Packed with real talk, tax strategy, and a little legal swagger.
Let’s break it down.
1. Payroll Compliance: Family Ties Don’t Exempt You from the Law
We’ll say it loud for the folks in the back: Hiring a family member does not exempt you from payroll rules.
If you’re paying someone for services even if they’re your spouse, sibling, or child, you’re an employer. That means:
- Withholding income taxes
- Calculating Social Security and Medicare taxes (FICA)
- Paying unemployment taxes (FUTA)
- Issuing correct tax forms (W-2, W9, 1099-NEC, etc.)
If you’re not doing those things, you’re not paying an employee. You’re writing checks. And that could land you in hot water with the IRS.
Let’s take an example: You run a small landscaping business and decide to pay your brother $1,000 a month to manage scheduling. You think, “He’s family, I’ll just cut him a check.” You don’t withhold taxes, don’t issue a W-2, and don’t report the income.
Congrats. You’ve just opened the door to penalties for:
- Failure to withhold employment taxes
- Failure to file proper forms
- Improper classification of a worker
- Underreported income on your brother’s return
Even if your intentions were noble, your execution wasn’t compliant.
This is where working with a qualified Austin tax accountant or tax preparer near you is game-changing. We’ll show you how to run payroll the right way, without risking an audit or losing your deduction.
2. Skip Payroll and You May Trigger the Gift Tax Instead
Here’s where things get a little dramatic: if you pay a family member without proper documentation, you might not just lose a deduction. You might walk straight into the gift tax arena.
If you’re giving someone money without proof of services rendered or formal payroll documentation, the IRS may reclassify those payments as gifts. If those gifts exceed the annual limit ($18,000 per person for 2025), you could be on the hook for gift tax filing and potentially taxes.
Even worse? The business loses the deduction.
You’re now in the position of having paid out of pocket and missing the tax benefit. That’s not smart business. That’s a tax headache.
Your move: Document everything. Have a written agreement. Outline duties. Use payroll software. Work with a certified public accountant near you who can keep those lines clean between love and labor.
3. Legal vs. Tax Status: Know the Distinction
Let’s be clear: the IRS doesn’t care that you legally can hire your 15-year-old to update your company website. What they care about is whether you’re following the right tax protocol based on your business structure.
There are special rules when it comes to family:
- Sole Proprietors: If you employ your under-18 child, you’re exempt from FICA (Social Security and Medicare taxes) and FUTA (unemployment tax). This can be a big win. Less tax liability for both of you.
- LLCs or S-Corps: Even if you own the business 100%, hiring your child triggers standard tax treatment. You’ll need to withhold payroll taxes and submit employment forms like you would for any non-relative.
This is the kind of nuance that gets missed when business owners wing it. It’s not that you can’t hire your kid, it’s that doing so through your S-corp means a very different tax implication than through your sole prop.
Don’t guess. Work with a CPA in Austin, Texas that gets how family, finance, and tax law intersect. Because you don’t just want compliance. You want advantage.
4. The IRS Loves a Clean Audit Trail. Use Payroll Software.
You’ve got options:
- Gusto: Clean UI, integrates with QuickBooks, handles taxes and direct deposit.
- QuickBooks Self-Employed: Great for solopreneurs, contractors, and keeping tabs on 1099 income.
- FreshBooks, ZohoBooks, and others: Ideal for tracking contractor pay or irregular hours.
If you’re paying a spouse or child and not using software, here’s what you’re risking:
- Inconsistent pay history
- No audit trail
- Missing forms (like the 1099-NEC, W9, 1099-K)
- Inaccurate year-end reporting
We’ve had clients come in with handwritten ledgers, vague records, and a trail of Venmo payments labeled “work.” That’s not payroll. It’s a paper trail of red flags.
As your Austin accounting service, we don’t just help you use these platforms. We integrate them into your larger tax strategy, ensuring compliance and maximizing deductions.
5. Paying Your Child Might Kill Their Dependent Status
This one’s sneaky. Let’s say your child earns more than the IRS threshold for the year and now can’t be claimed as a dependent. You’ve just lost:
- A potential $500 tax credit
- Increased standard deduction options
- Eligibility for certain tax credits (like education-related benefits)
And here’s where it gets really complex: if your child is working in your business and saving for college, those earnings may impact financial aid eligibility or their standing under FAFSA.
In short: Pay your child too much, too soon, and they’re financially independent in the eyes of the tax world but still very dependent at home.
Want to run those numbers? We’ve got self-employment tax calculators, income projections, and certified CPAs who can help you plan every dollar with intention.
Bonus Tip: Watch for the Ripple Effects on Retirement & Benefits
When you bring a spouse onto payroll, you might also be opening up eligibility for benefits like:
- 401(k) contributions
- Health insurance reimbursements
- Employer-sponsored retirement planning
But again, the paperwork must be pristine. Use a certified CPA near you to run scenarios. You might be able to funnel earnings into retirement savings in a tax-advantaged way but only if the IRS sees the relationship as legitimate employer-employee.
Pro tip: Pay enough to fund a benefit, but not so much that it shifts tax brackets or triggers unnecessary self-employment tax.
The Legal-But-Strategic Way to Pay Family
So, what’s the bottom line? Paying your family members is absolutely legal. In fact, it can be a savvy move. Boosting income within your household, keeping money in the family, and potentially saving you thousands in taxes.
But only if you do it right.
That means:
- Using payroll software
- Issuing proper tax forms
- Classifying income correctly
- Working with a tax professional to assess broader implications (like dependent status, retirement planning, and tax strategy)
At Insogna, we’ve helped hundreds of real estate investors, business owners, and entrepreneurs across the country pay their family the right way. We’re not just your tax preparer, we’re your strategic partner in business growth.
Want to Pay a Loved One the Right Way? Let Us Show You How.
It’s tempting to treat your business like your home whether it’s personal, flexible, informal. But when it comes to payroll, that’s a risk you don’t want to take.
We’ll help you:
- Navigate the W9 tax form, 1099 NEC form, and self-employment tax rules
- Avoid triggering gift tax issues
- Ensure you stay IRS-compliant while maximizing tax benefits
- Keep your books clean, clear, and ready for anything
Whether you’re a growing startup or a seasoned small business, you deserve expert guidance from a team that treats your goals like our own.
Insogna: a firm filled with Austin’s most trusted accountants for business owners who don’t have time to mess around.
Let’s make family payroll work for everyone.