Hiring Family Members in Your Medical or Dental Practice

Why Physicians Hire Family Members

Medical and dental practice owners frequently ask whether hiring a child or spouse makes sense from a tax perspective. The answer depends on your practice structure, the nature of the work performed, and your broader wealth and retirement goals. When executed properly, family employment can shift income from high brackets to lower ones, fund retirement accounts for the next generation, and teach children valuable business skills. When done improperly, it invites IRS scrutiny, penalties, and disallowed deductions.

This page explains the substantive requirements for employing family members, how payroll tax rules differ by entity type, the retirement account opportunities that legitimate employment creates, and the compliance pitfalls that attract IRS attention. Physicians in the 35% or 37% brackets—which for 2026 begin at $512,450 and $768,700 respectively for married taxpayers filing jointly—benefit most when family employment is part of a coordinated tax-first wealth architecture rather than an isolated tactic.

Legitimate Employment: Real Work, Reasonable Pay, and Records

The Internal Revenue Code allows you to employ anyone, including relatives, and deduct their wages as an ordinary and necessary business expense under IRC Section 162. The IRS does not prohibit family employment, but it does require that the arrangement be genuine and conducted at arm's length. Three core principles apply.

Bona Fide Services

The employee must perform real, substantive work that genuinely assists the practice. Common roles for children include filing, data entry, inventory management, social media posting, website updates, cleaning exam rooms, answering phones, and appointment scheduling. Spouses often handle bookkeeping, human resources, patient outreach, marketing, and office management. The key is that the tasks are necessary for your practice and actually performed by the family member. The IRS has disallowed deductions where a taxpayer claimed wages for a young child who could not plausibly perform the claimed duties.

Reasonable Compensation

Wages must be reasonable for the work performed and consistent with what you would pay an unrelated third party for the same duties. For children, this typically means an hourly rate appropriate to their age, skill, and local market. Paying your 14-year-old $50 per hour to file papers would raise red flags; paying $15 to $20 per hour for legitimate clerical work generally would not. For spouses, compensation should reflect the role's complexity, hours worked, and prevailing wages in your area. IRS Publication 15 (Circular E), Employer's Tax Guide, provides general guidance on employee classification and wage reporting.

Documentation

The IRS expects contemporaneous records proving the employment relationship. Maintain timesheets, written job descriptions, copies of paychecks or direct deposit records, and contemporaneous logs of tasks performed. For children, a simple weekly timesheet signed by a supervisor (you or a practice manager) is usually sufficient. For spouses in significant roles, a formal employment agreement, performance reviews, and periodic documentation of duties can strengthen your position. The burden of proof rests on the taxpayer, so diligent recordkeeping is essential.

Payroll Tax Treatment by Entity Type

One of the most significant variables in family employment is how payroll taxes apply. Federal Insurance Contributions Act (FICA) taxes—6.2% Social Security and 1.45% Medicare on both the employer and employee side—and Federal Unemployment Tax Act (FUTA) taxes can be avoided or reduced depending on your practice structure and the family member's relationship and age.

Sole Proprietorships and Single-Member LLCs

If you operate as a sole proprietor or a disregarded single-member LLC, special rules apply when employing your children. Under IRC Section 3121(b)(3) and IRC Section 3306(c)(5), wages paid to your child under age 18 are exempt from Social Security, Medicare, and federal unemployment taxes. Wages paid to your child aged 18 through 20 are exempt from FUTA but subject to FICA. Once your child turns 21, standard FICA and FUTA apply. The IRS discusses these exemptions in Publication 15, Employer's Tax Guide.

When employing your spouse in a sole proprietorship, wages are subject to income tax withholding and FICA, but exempt from FUTA under IRC Section 3306(c)(5). This means you avoid the 6.0% federal unemployment tax on the first $7,000 of wages, a modest but straightforward benefit.

Partnerships

If your practice is a partnership and you employ your child, the FICA and FUTA exemptions apply only if the partnership consists solely of you and your spouse. If any other partner is involved, the exemptions disappear and standard payroll taxes apply to your child's wages.

S Corporations and Multi-Member LLCs Taxed as S Corporations

If your practice is an S corporation, the payroll tax exemptions for children do not apply. Wages paid to your child or spouse are subject to full FICA and FUTA withholding and matching, just as they would be for any unrelated employee. This is a significant difference and often makes family employment less attractive from a pure payroll-tax perspective in the S corporation context. However, S corporations remain popular among medical practice owners for other reasons, including reasonable compensation planning and self-employment tax savings on distributions.

C Corporations

C corporations follow the same rules as S corporations: all wages paid to family members are subject to standard FICA and FUTA. However, few small medical practices operate as C corporations due to double taxation concerns.

Income Shifting and Bracket Arbitrage

Employing a child or spouse allows you to convert what would have been income taxed at your marginal rate into deductible wages taxed at the recipient's lower rate. For 2026, a single filer can claim a standard deduction of $16,100, meaning the first $16,100 of earned income is sheltered from federal income tax. If your child has no other income, you can pay up to that amount with zero federal income tax liability for the child and a deduction at your 35% or 37% marginal rate.

For example, a cardiologist in California paying $15,000 in wages to a teenage child saves approximately $5,550 in federal tax (at 37%) plus state tax, while the child owes zero federal income tax after the standard deduction. Over multiple years and multiple children, this can represent meaningful wealth transfer and tax savings. The IRS has not challenged reasonable wages paid to children for legitimate work, provided the requirements above are met.

Retirement Account Opportunities

One of the most compelling reasons to employ family members is the ability to fund their own retirement accounts with earned income. Earned income is a prerequisite for contributing to an Individual Retirement Account (IRA) or Roth IRA, and legitimate wages satisfy this requirement regardless of the employee's age.

Roth IRAs for Children

A child with earned income can contribute to a Roth IRA up to the lesser of their earned income or the annual contribution limit. For 2026, the IRA contribution limit (traditional and Roth combined) is $7,500 for people under age 50, according to the IRS. Contributions to a Roth IRA are made with after-tax dollars but grow tax-free, and qualified distributions in retirement are also tax-free. Starting a Roth IRA at age 15 or 16 gives decades of tax-free compounding. The IRS provides guidance on Roth IRAs in Publication 590-A, Contributions to Individual Retirement Arrangements.

A parent or grandparent can gift the funds to the child to make the Roth contribution, effectively converting taxable income into a tax-free wealth vehicle. This strategy is particularly powerful when combined with the income-shifting benefit described above.

Traditional and SEP IRAs

Children and spouses can also contribute to traditional IRAs, though the deductibility of those contributions may be limited if they or their spouse are covered by an employer retirement plan. SEP IRAs are generally less common for family employees unless they work substantial hours and meet the plan's eligibility requirements.

401(k) Plans

If your practice sponsors a 401(k) or other qualified retirement plan, family employees who meet the plan's eligibility criteria must generally be allowed to participate on the same terms as other employees. This can be an advantage if you want to maximize family members' retirement savings, but it requires careful plan administration and non-discrimination testing. Physicians interested in maximizing retirement contributions often explore cash balance plans alongside or instead of traditional 401(k) arrangements.

Common IRS Compliance Problems

The IRS scrutinizes family employment arrangements more closely than arm's-length hires. Audits and disputes typically arise in the following contexts.

Excessive or Unreasonable Wages

Paying far more than market rate for the work performed is the most common red flag. If your practice pays your 12-year-old $40,000 per year for occasional filing, the IRS will likely reclassify the excess as a non-deductible personal expense or distribution. Reasonableness is judged by the duties, hours, skill required, and local wage rates.

Lack of Documentation

In audits, the IRS often requests timesheets, job descriptions, check copies, and proof that work was actually performed. Taxpayers who cannot produce contemporaneous records frequently lose deductions. The Tax Court has disallowed wage deductions where the only evidence was the taxpayer's testimony, particularly when the child was very young or the hours claimed were implausible.

Failure to Withhold and Remit Payroll Taxes

Even when FICA or FUTA exemptions apply, you must still withhold federal income tax if wages exceed the threshold, file Form W-2, and comply with state withholding and unemployment rules. Sole proprietors employing children sometimes mistakenly believe they can skip all payroll filings; this is incorrect. State rules vary, and many states do not mirror the federal FICA exemptions for children. Consult your state's employment development or labor department for specifics.

Misclassification as Independent Contractors

Some practitioners attempt to pay family members as independent contractors (Form 1099-NEC) rather than employees (Form W-2) to avoid payroll tax and reporting. The IRS applies the same common-law employee tests to family members as to any other worker. If the practice controls when, where, and how the work is performed, and provides the tools and workspace, the worker is generally an employee. Misclassification can result in back taxes, penalties, and interest. The IRS provides guidance on worker classification in Publication 15-A, Employer's Supplemental Tax Guide.

State and Local Considerations

State income tax, unemployment insurance, workers' compensation, and wage-and-hour laws all apply to family employees. States do not always conform to federal payroll tax exemptions. For example, California generally requires state payroll tax withholding and unemployment insurance contributions for all employees, including children, regardless of federal exemptions. Physicians in states with high marginal rates—such as California, New York, and New Jersey—should model the combined federal and state impact before implementing family employment strategies. Similarly, Florida and Texas residents benefit from the absence of state income tax, simplifying the analysis.

Integration with Broader Tax and Wealth Planning

Hiring family members is rarely a standalone strategy. It works best when integrated with advanced tax strategies, entity structure planning, retirement plan design, and estate planning. For instance, wages paid to children reduce your taxable income today and fund Roth IRAs that compound tax-free for decades, effectively transferring wealth outside your estate without gift tax consequences (since the wages are earned income, not gifts). When combined with a backdoor Roth IRA strategy for yourself and appropriate retirement plan contributions, family employment can be one component of a comprehensive approach to minimizing lifetime tax and building intergenerational wealth.

Physicians should also consider the interplay with kiddie tax rules (IRC Section 1(g)), which generally do not apply to earned income but do apply to unearned income such as investment returns in a custodial account. Earned wages are taxed at the child's own rates, not the parent's, making employment a more favorable income-shifting vehicle than passive investments for minors.

Choosing an Advisor and Next Steps

Family employment arrangements require careful planning, disciplined execution, and ongoing compliance. The tax benefits are real, but so are the risks of disallowance, penalties, and audit adjustments. Physicians should work with a tax advisor who understands the nuances of entity selection, payroll tax exemptions, retirement plan rules, and IRS audit triggers. Look for a professional who integrates family employment into a broader tax and wealth strategy rather than treating it as a checkbox item.

GenWealth 360 helps physicians and dentists nationwide design and implement family employment strategies as part of a tax-first wealth architecture. If you are considering hiring a child or spouse—or already employ family members and want to ensure compliance and optimize the arrangement—schedule a consultation to discuss your situation in detail. Book your consultation at https://calendly.com/genwealthinc/physicians-consultation-genwealth360 or call 877-436-9360.

This article is for general educational purposes and is not tax, legal or investment advice. Tax law changes often and its application depends on your facts. Figures reflect 2026 rules as published by the sources listed above. Consult a qualified professional before acting. See our editorial policy.