One of the advantages of operating your own business is hiring family members. However, the employment tax requirements for family employees may vary from those that apply to other employees.
How Spouses Earn Social Security Benefits
A spouse is considered an employee if there is an employer/employee type of relationship, i.e., the first spouse substantially controls the business in terms of management decisions and the second spouse is under the direction and control of the first spouse. If such a relationship exists, then the second spouse is an employee subject to income tax and FICA (Social Security and Medicare) withholding. However, if the second spouse has an equal say in the affairs of the business, provides substantially equal services to the business, and contributes capital to the business, then a partnership type of relationship exists and the business's income should be reported on Form 1065, U.S. Return of Partnership Income (PDF).
Both Spouses Carrying on the Trade or Business
If spouses carry on a business together and share in the profits and losses, they may be partners in a partnership whether or not they have a formal partnership agreement. Spouses should report income or loss from the business on Form 1065, U.S. Return of Partnership Income (PDF). They should not report the income on a Form 1040 Schedule C, Profit or Loss From Business (PDF) in the name of one spouse as a sole proprietor.
If each spouse is a partner in a partnership, each spouse should carry his or her share of the partnership income or loss from Form 1065, Schedule K-1, Partner's Share of Income, Credits, Deductions, etc. (PDF), to their joint or separate Form(s) 1040. Each spouse should include his or her respective share of self-employment income on a separate Form 1040 Schedule SE, Self-Employment Tax (PDF). Self-employment income belongs to the person who is the member of the partnership and cannot be treated as self-employment income by the nonmember spouse, even in community property states. This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the social security tax limitation. Refer to Publication 553, Highlights of 2003 Tax Changes , for further information about self-employment taxes.
One Spouse Employed by Another
If your spouse is your employee, not your partner, you must pay Social Security and Medicare taxes for him or her. The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and Social Security and Medicare taxes, but not to FUTA tax. For more information, refer to Publication 15, Circular E, Employer Tax Guide.