Wages pay for work. Dividends pay for ownership. A loan moves money without paying for anything, which is exactly why it is the one that gets recharacterized. Most family pay problems are a wages question that was answered with a dividend, or a dividend question answered with a loan.
Four questions pick the tool. Does the person do a job for the business? Is that job defined, with hours, pay, and someone who can approve it? Do they own a piece of the company? Is there a written agreement that says so? If the answer to the first two is yes, pay wages. If the answer to the third is yes and the first two are no, pay dividends. If neither applies, there is no payment to make.
How to read the numbers on this page
Sourced. The employer compensation figures come from the Bureau of Labor Statistics' Employer Costs for Employee Compensation release for June 2026, published September 9, 2026: $46.89 an hour for private industry in total, of which $32.82 is wages and $14.07 is benefits, plus the size-band splits that follow. The payroll tax rates, the $184,500 Social Security wage base, and the 0.9 percent Additional Medicare Tax threshold come from IRS Topic 751. The rules for a child under 18 come from the IRS's family employee guidance.
Worked examples. The $60,000 salary that costs about $82,500 at a 50-to-99-person company and about $89,500 at 100-plus is arithmetic we did on the BLS percentages: $60,000 divided by 0.727, then divided by 0.67. The BLS published the percentages, not your cost. Change the salary or the headcount and the number moves.
Ours. The loaded-cost range we quote — about 38 percent on top of wages at a 50-to-99-person company, about 49 percent at 100-plus — is arithmetic on the BLS percentages rather than a statistic of its own, so change the size band and the number changes with it. The rule that a family member doing a real job gets paid for it is our position, not a published rule.
One caution. The IRS applies the common law test to worker classification, and says plainly that there is no set number of factors that decides it. That is why this page does not hand you a checklist that decides it for you.
Situation
Family member does a real, defined job.
Family member owns equity and does no job.
Family member does a job and owns equity.
Family member does neither.
Pay them with
Wages, at market rate for the role, plus benefits and payroll tax.
Dividends, in proportion to the ownership, nothing more.
Wages for the job, dividends for the stake, on separate schedules.
Nothing from the company. A gift, a loan with terms, or nothing at all.
What a family employee actually costs
Wages are the smallest part of the cost of employing somebody. In private industry as of June 2026, total compensation averaged $46.89 an hour, of which wages were $32.82, or 70.0 percent, and benefits were $14.07, or 30.0 percent (BLS, Employer Costs for Employee Compensation, released September 9, 2026).
Small employers carry a lighter load than large ones. For private industry firms with 1 to 99 workers, total compensation averaged $38.43 an hour: wages of $28.33, or 73.7 percent, and benefits of $10.10, or 26.3 percent (BLS ECEC, Table 6, June 2026). For firms with 50 to 99 workers, total compensation averaged $41.03 an hour: wages of $29.84, or 72.7 percent, and benefits of $11.19, or 27.3 percent (BLS ECEC, Table 6, June 2026). At 100 workers and more, benefits were $18.80 of $56.95, or 33.0 percent (BLS ECEC, Table 6, June 2026).
Run that arithmetic on your own company before you set the salary. A $60,000 salary at a company with 50 to 99 workers costs roughly $82,500 all in, because benefits are about 27 percent of total compensation: $60,000 divided by 0.727. At 100 employees it is closer to $89,500, because the benefit share is 33 percent and wages are the remaining 67 (BLS ECEC, June 2026). The salary is the number you negotiate. The number that lands on the bank account is the one you have to fund, and it is the one the family member will compare against what a stranger would be paid.
That gap is also why family pay goes wrong. When a relative is paid market rate for a real job, nobody argues about it. When the job is not real and the pay is not market, every conversation turns to fairness instead of work, and fairness has no answer.
The payroll tax on family is not the payroll tax on anyone else
The IRS rules for family employees differ by entity type and by age, and the difference is large enough to be worth a conversation before you choose your entity.
If your business is a corporation and your child under 18 works in it, the child's wages are subject to income tax withholding, Social Security, Medicare, and FUTA regardless of age. If the business is your sole proprietorship, or a partnership whose partners are all the parents, the child's wages are exempt from Social Security and Medicare but are still subject to income tax withholding (IRS, Family employees, page last reviewed October 11, 2026). If a parent works for a child, the parent's wages are subject to withholding, Social Security, and Medicare but not FUTA. If one spouse works for the other, the IRS says there are several ways to structure it, each with different tax treatment, so that one has to be chosen deliberately.
So for a family with a child under 18 in the business, the choice of entity is a payroll tax decision rather than a legal formality. Same work, same person, different payroll tax. Once the child is 18, none of this applies and the wages are ordinary wages like everyone else's.
The rest of the family payroll is ordinary. Social Security runs at 6.2 percent and Medicare at 1.45 percent for each of employer and employee, on wages up to the Social Security wage base of $184,500 for 2026 (IRS Topic 751, page last reviewed November 9, 2026). The Additional Medicare Tax of 0.9 percent applies to wages above $200,000, with no employer match (IRS Topic 751, page last reviewed November 9, 2026).
Trap one: calling a family member a contractor
The label does not decide this. The IRS applies the common law test and looks at the entire relationship, focusing on the right to direct and control. There is no magic or set number of factors that makes the worker an employee or an independent contractor, and the IRS groups the evidence into behavioral control, financial control, and the type of relationship (IRS, Independent contractor (self-employed) or employee, page last reviewed May 19, 2026).
If you classify an employee as an independent contractor and you have no reasonable basis for doing so, you may be held liable for employment taxes, including the employer's share of Social Security and Medicare, plus federal unemployment tax, and for withholding obligations (same source). Two provisions give relief, and they are worth keeping apart. Section 530 of the Revenue Act of 1978 is the one that turns on a reasonable basis: to get relief you need a reasonable basis for not treating the worker as an employee, you must file all required federal information returns on a basis consistent with your treatment of the worker, and you must not have treated any worker holding a substantially similar position as an employee for any period beginning after 1977 (IRS, Publication 1976, Section 530 Employment Tax Relief Requirements). Section 3509 is the fallback, and it caps the liability rather than excusing it: the liability is determined as if the amount required to have been withheld for income tax were 1.5 percent of the employee's wages and the employee share of Social Security and Medicare taxes were 20 percent of the amount that would have been imposed, rising to 3 and 40 percent where the required information returns were not filed and the failure was not due to reasonable cause, and the section does not apply at all where the liability is due to an intentional disregard (Internal Revenue Code section 3509). The worker can use Form 8919 to report their share of uncollected Social Security and Medicare taxes, and eligible businesses can use the Voluntary Classification Settlement Program to reclassify a class of workers as employees for future periods (IRS, Form 8919, page last reviewed July 31, 2026; IRS, Voluntary Classification Settlement Program, page last reviewed September 8, 2026).
For a family business the practical test is short. If your brother-in-law works the hours you set, uses the equipment you provide, and cannot send someone else to do it, he is an employee. Put him on payroll, or give him real contractor terms and real contractor responsibility, including the ability to serve other clients and the risk of losing work you do not want to lose.
Trap two: promising to pay the payroll tax later
Payroll tax you did not remit does not go away. It becomes a liability the company does not pay, and it attaches to you personally. The IRS rule is about status, duty, and authority rather than the title on the business card. The manual says responsibility is a matter of status, duty, and authority, and it lists what a responsible person has: the duty to perform, the power to direct the act of collecting trust fund taxes, accountability for and authority to pay trust fund taxes, and the authority to decide which creditors get paid. It also says significant control means more than having the mere mechanical duty of signing checks or preparing tax returns, or having a title that appears to have authority, and its own example is a general manager who was never a shareholder, director, or officer and still signed most of the company's checks (IRS Internal Revenue Manual 5.7.3, page last reviewed April 30, 2026).
Willfulness is defined as intentional, deliberate, voluntary, reckless, knowing, not accidental (IRM 5.7.3, page last reviewed April 30, 2026). No bad motive is required, and preferring to pay employees rather than the government when there is not enough money is treated as willful. The manual's own example contrasts that choice with prorating the available funds between payroll and taxes.
In a family company this lands hard, because there are two people in the room who can sign the return. If your son runs payroll and you both decide to wait until the money comes in, one of you is going to pay that personally, and it will probably be the one who can least afford to. Your son being on the payroll is not a shield for you, and your title is not a shield for him.
Trap three: paying the relative who has no job and no equity
If a family member does no work for the company and owns no equity, there is no wage and no distribution to make. A payment in that situation is a gift, a loan, or an advance against work that has not happened, and all three are a problem. A gift has tax consequences of its own, which are covered in bringing a family member into ownership. A loan with no terms is the classic below-market loan the IRS recharacterizes, and that is covered in the owner draw policy.
A distribution is not a shortcut either, because the basis rules apply to everyone. The IRS position is that a loss, deduction, or distribution decreases stock basis, that only non-dividend distributions reduce stock basis, and that a non-dividend distribution in excess of stock basis is taxed as a capital gain on the shareholder's personal return (IRS, S corporation stock and debt basis, page last reviewed June 7, 2026). If your cousin owns 5 percent of the company, he can be paid a proportionate share of the profit and not one dollar more, without creating a basis problem.
The rule
Work gets wages, ownership gets dividends, and nothing else gets money out of the company. A family member on payroll is a job with a pay rate, a supervisor, and a job description. A family member who owns the company and does not work in it is paid on the same terms as every other owner of that size.
What to do this week
Six jobs. The first one usually produces the finding.
The owner's week
List every family member on the payroll, on a 1099, or drawing money from the company. Write down the job each one actually does. If you cannot write the job description, that is the finding.
Check the entity type against each family member's age. A child under 18 working in a corporation is paying FICA and FUTA where a sole proprietorship would not.
Recalculate each family salary at market rate for the role, then add the loaded cost for your size and see whether the business can carry the total. Measured against wages rather than against the whole compensation package, the BLS benefits figures mean about 38 percent on top of wages at a 50-to-99-person company and about 49 percent at 100-plus.
Write one page per family member: role, pay, who approves it, and what happens if the role changes. Family pay disputes are almost always the absence of a written answer rather than the presence of a wrong one.
Fix any worker who is really an employee before year end. Reclassify, and use the Voluntary Classification Settlement Program if the IRS relief programs fit your facts.
Have the accountant confirm that payroll tax is being withheld and remitted on every family employee, and confirm whether you have personally signed anything that makes you responsible for it.
BLS ECEC Table 6 — Employer costs by employer size is the source of the size splits used here: $38.43 an hour for firms with 1 to 99 workers, $41.03 for 50 to 99, and $56.95 for 100 or more, with the wage and benefit shares behind each.
IRS Topic 751 — Wages and Other Taxable Compensation is the source of the 6.2 percent Social Security rate, the 1.45 percent Medicare rate, the $184,500 Social Security wage base for 2026, and the Additional Medicare Tax threshold. Last reviewed November 9, 2026.
IRS — Family employees is the source of the rules that differ by entity type and by age for a child under 18 and for a parent working for a child. Last reviewed October 11, 2026.
IRS — Independent contractor (self-employed) or employee is the source of the common law test and of the three groupings the IRS uses: behavioral control, financial control, and type of relationship. Last reviewed May 19, 2026.
What is ours rather than published. The $82,500 and $89,500 loaded costs are our arithmetic on the BLS percentages. The BLS published the percentages; we published the example.
Frequently Asked Questions
Is it cheaper to pay my son as a contractor?
Only if he is genuinely a contractor, and the IRS decides that on the facts of how the work is done rather than on what the paperwork says. It looks at behavioral control, financial control, and the type of relationship, and it states plainly that there is no set number of factors that decides it. If he works your hours, your equipment, your customers, and cannot send a substitute, he is an employee. Then the cost is payroll tax and benefits, and the saving you thought you had was the exposure you now carry.
Do we have to pay family members the same as everyone else?
For the work, yes, and that is the number you write down. Paying a relative less than the market for the same job is not a family arrangement, it is a lower wage with a tax problem attached. Family money is a good reason to pay someone more, not less, as long as the extra is documented as something else: a distribution, a bonus with a stated basis, or a documented loan.
My child is 17 and works in the business. What changes when he turns 18?
The payroll tax treatment of his wages changes with the entity type, not just his age. In a parent-owned corporation, a child under 18 is subject to income tax withholding, Social Security, Medicare, and FUTA regardless of age, while in the parent's sole proprietorship Social Security and Medicare do not apply to him but withholding still does. Check the entity before his birthday, because the choice of entity is a payroll tax decision.
What if my son is an owner but never works in the business?
Then he is paid a distribution on his ownership, in proportion to it, and nothing else. The basis rules apply to him exactly as they apply to you: distributions reduce stock basis, and a non-dividend distribution above basis is a capital gain to him. He does not need a job title to justify a payment, and giving him one usually creates the payroll tax problem you were trying to avoid.
Key Takeaways
•Wages for work, dividends for ownership, and no other tool for paying family.
•A $60,000 family salary costs roughly $82,500 at a 50 to 99 person company, and closer to $89,500 at 100 employees.
•The entity type changes the payroll tax on a child under 18, so pick the entity with the pay structure in mind.
•The label 1099 does not decide worker classification. The right to direct and control does.
•If payroll tax is not remitted, the IRS looks for who had the effective power to pay it. Title does not protect you and neither does kinship.
Put a pay rule behind the family
A finance office writes the family pay policy, runs the payroll correctly, and keeps the loaded cost inside what the business can carry.
Dan SettelNov. 11, 2026
