How to Compensate Family Members Who Work for Your Business

When it comes to pay, your family isn't special.
Knowing the best practices for hiring and compensating family members can keep the law, IRS and other employees off your back. (Photo: racorn/Shutterstock)
Knowing the best practices for hiring and compensating family members can keep the law, IRS and other employees off your back. (Photo: racorn/Shutterstock)
peri-berger

“People believe that if they are working with family members, the law does not necessarily apply as it otherwise would.” -Peri Berger (Photo: Peri Berger)

Every small business owner who has family members on the payroll has faced the same dilemma: How much do I pay them?

“People believe that if they are working with family members, the law does not necessarily apply as it otherwise would,” said Peri Berger, an attorney with the law firm Harris Beach who works with startups and small businesses. But, in fact, this thinking can lead to potential problems with the law, the IRS and your other employees.

Here are four best practices for hiring and compensating a family member.

Consult a professional first

As when making any major business decision, owners should enlist the help of relevant lawyers and accountants to ensure they comply with local, state and federal laws. When calculating how much to pay family members, this is especially important because there are no hard-and-fast rules related to compensation.

The laws around paying any employee can differ by the type of business structure (sole proprietorship, corporation, S corporation, partnership, limited liability company) according to Steven J. Weil, president of RMS Accounting, a family-owned firm in Wilton Manors, Florida.

“Ownership is also a variable,” Weil said. “Are the family members actually employees, or do they have an ownership interest in the business?”

Taxes also vary, depending on where you live. “Questions of taxes relate to federal, state, and sometimes local law,” Berger said. “It is critical to obtain the advice of a tax professional, such as an accountant or tax lawyer, when dealing with these issues.”

Treat all employees, including family members, the same

ira-bryck

“Keep gifts of love out of the business. Pay for merit, not family relationships.” -Ira Bryck (Photo: Ira Bryck)

“In many family businesses, family members are either underpaid, because of a ‘one day this will be yours’ mentality, or overpaid because of informal bonuses and gifts of love,” said Ira Bryck, founder of the Family Business Center of Pioneer Valley, an educational organization and consulting company that was previously a part of the University of Massachusetts Amherst and is now independent.

The best practice for family business owners is to attempt “family blindness,” Bryck said. That is, treat kin like any other employee when it comes to salary, bonuses and dividends.

“Keep gifts of love out of the business,” he said. “Pay for merit, not family relationships.”

Lisa Chu, owner of Black N Bianco, a formal clothing company for children in El Monte, California, said she learned this lesson the hard way.

“In the past I have given my family members more compensation and bigger bonuses, based off their relationship with me. That proved to be disastrous. The morale of the office sank to an all time low and productivity suffered because of it.”

After consulting with her accountant, Chu now pays her family the same as everyone else and all compensation, bonuses, and promotions are based solely on performance.

Formalize compensation

According to Berger, laws do not always differentiate between family employees and non-family employees, so everyone needs the same paperwork.

lisa-chu

Businesses should put everything in writing for both family employees and non-family employees, according to Lisa Chu, owner of Black N Bianco. -Lisa Chu (Photo: Lisa Chu)

“If the family member is an employee, the situation should be formalized in the same form of written contract or structure that would be used if the employee was not a family member,” Berger said. “If a family member invests in the business, formalize it as you would with any other investor. This protects everyone involved.”

Putting everything in writing also benefits other employees in the company.

“Non-family employees will feel that they are on an even playing field and a true member in your small business,” Chu said. “As a result, they won’t resent any family members and will contribute to helping everyone improve the business.”

Communicate with everyone

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“With my family, we have a deal where we state at the beginning of a conversation if we are talking as family members or boss-employee.” -Jen Searfoss (Photo: Jen Searfoss)

Jennifer Searfoss, owner of SCG Health, a healthcare consulting firm, brought her sister onto the payroll when she started her business in 2011 to manage the bookkeeping. Today, her sister is her CFO — and has a written contract like everyone else.

To navigate paying a mix of family and non-family, Searfoss keeps lines of communication open with all hires.

“I get a feeling for other staff members and their perceptions of the business,” she said. “And with my family, we have a deal where we state at the beginning of a conversation if we are talking as family members or boss-employee. I consider all of my team members to be my ‘work family.’”

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