If you have a family and own a business, you’ve probably thought about employing family members. If you have, you might have heard of a family management company(FMC). Setting up a FMC can be a great strategy for business owners. A family management company can help reduce your taxes. In this post, we’ll explore how a family management company works, whether you need one, the tax-saving strategies behind it and a detailed case study on how effective FMC can be for your family. 

What is a Family Management Company?

A Family Management Company is simply another company that you own, separate from your main business. It can be structured in various ways, such as a single-member LLC, or as an S-corp. The primary role of an FMC is to provide services to other companies you own, like an S corporation, LLC, or real estate holdings. For instance, if you own rental properties, an FMC can manage them and receive management fees, which can lead to additional tax write-offs.

How Does a Family Management Company Work?

When you set up a family management company, the idea is to have it offer services to your main business or properties. This can include managing your business operations, employing family members, or even managing rental properties.

For example, if you own a business and a family management company, your business can pay management fees to the FMC for services like staffing, payroll, or even property management. If you own real estate, your rental properties can pay the FMC a management fee, which consolidates the deductions for all your properties under one entity, simplifying tax filing and maximizing deductions.

Tax Strategy Behind a Family Management Company

The tax strategy of a family management company revolves around the ability to take deductions for services provided by the FMC to your businesses or properties. You can deduct expenses such as management fees, owner salaries, and certain fringe benefits. Additionally, if structured properly, a family management company could help you take advantage of health insurance strategies, retirement benefits, and even property write-offs.

Does It Really Save You Money on Taxes?

In most cases, yes. However, the success of this strategy depends on proper documentation and planning. It’s essential to have a clear intent behind the family management company and to ensure that all paperwork is in order before implementing this strategy. Consulting a tax advisor is crucial, as they can guide you on how to structure your FMC and what benefits you can claim. Without a well-documented plan, you might not reap the full tax-saving benefits.

Is It Complicated to Set Up?

Setting up an FMC is relatively straightforward, especially if you already own a business or real estate. The complexity increases when deciding on the entity type and ensuring that the management company operates within legal guidelines. For example, a C corporation setup might be advantageous for tax purposes, but this depends on your specific situation.

Case Study: Jill, Her Family Management Company, and the Tax Benefits of Paying Her Sons

Background: Jill is a successful real estate agent and property owner. She owns multiple rental properties and also operates an LLC under her real estate business. Jill is always looking for ways to reduce her tax liability while supporting her family’s financial future. She has two teenage sons, Ben and Nick, who are eager to help with the family business. After consulting with a financial advisor, Jill decides to set up a family management company (FMC) to hire her sons and pay them a reasonable wage for their help. This strategy allows her to save on taxes, teach her sons about money management, and set them up for future financial success.

How Jill’s Family Management Company Works:

Jill’s Real Estate and Rental Property Business:

• Jill operates a successful real estate business and owns several rental properties. These assets generate income and often require maintenance, marketing, and other business-related tasks. Additionally, Jill lists properties for sale through her real estate business.
• Jill’s LLC provides a tax structure that allows her to manage her business income and expenses efficiently. As a real estate agent and property owner, Jill is always looking for legitimate ways to reduce her taxable income through deductions. One way to do this is by hiring her sons to help with various tasks related to the properties she manages and sells.

The Family Management Company Setup:

• Jill creates a family management company (FMC), which she uses to employ her two sons, Ben and Nick. The FMC is a separate entity set up under her LLC to handle all income and expenses related to family services. She pays Ben and Nick wages for their work in the business, which include property maintenance tasks such as raking the leaves, mowing the grass, cleaning, painting, and maintaining the properties. In addition, they help with tasks related to Jill’s real estate listings, such as handling social media posts and bookkeeping.
• Key Tasks for Ben and Nick:
  • Maintenance: Mowing the grass, raking leaves, cleaning common areas, painting walls, and performing minor repairs at Jill’s rental properties.
  • Real Estate Assistance: Managing social media accounts, creating property listings, organizing client communications, and doing basic bookkeeping tasks.
  • Other Miscellaneous Tasks: Assisting Jill with any additional administrative tasks required to keep her businesses running smoothly.

Fair Compensation for Ben and Nick:

• Jill ensures that the compensation she provides to Ben and Nick is fair and consistent with what she would pay any third-party worker for similar tasks. She maintains excellent records of the hours worked, wages paid, and the services provided to make sure everything complies with tax regulations.
• Wages Paid: Both Ben and Nick work approximately 18-25 hours per week during the summer and 10 hours per week during the school year. At a rate of $18 per hour, they each earn approximately $12,000 annually through the family management company. The work is structured to meet the needs of the family business while providing the sons with reasonable compensation.
• Annual Compensation per Son:
  • 667 hours x $18 per hour = $12,000 for each son.
• This structured approach ensures that Jill can deduct the wages as a business expense while providing her sons with income they can use for their own financial goals.

Tax Deductions for Jill:

• By hiring her sons through the FMC, Jill can deduct $24,000 ($12,000 for Ben and $12,000 for Nick) from her business income. This helps reduce her taxable income and, in turn, lowers her overall tax liability.
• Since Ben and Nick are employed by the family management company, their wages are subject to normal payroll taxes, but they are taxed at a lower rate than Jill would be. This means Jill is saving on self-employment taxes by paying her sons instead of hiring third-party contractors.
• The FMC’s expenses related to Ben and Nick’s wages reduce Jill’s taxable income, allowing her to save money that would have otherwise gone to contractors or other employees.

Setting Up Tax-Advantaged Accounts for Ben and Nick:

• Roth IRAs:
  • Jill sets up Roth IRAs for both Ben and Nick. Since they have earned income, they are eligible to contribute up to the annual limit ($7,000 for 2024) into their Roth IRAs. Jill helps them understand the importance of compound growth and the benefits of contributing to tax-free accounts at a young age.
  • Roth IRA Contributions:
    • Ben and Nick contribute $7,000 each into their Roth IRAs. Their contributions are made with after-tax money, but the growth in these accounts is tax-free. This allows them to save for college or other expenses, with the flexibility to use the funds later without worrying about taxes on the investment gains.
• Cash Value Life Insurance:
  • Jill also sets up cash value life insurance policies for both Ben and Nick. These policies will accumulate cash value over time, which they can borrow against tax-free in the future for college or other needs. The growth in the policies is also tax-deferred, meaning they won’t owe taxes on the earnings as long as the policy remains in force.
  • The life insurance policies also teach Ben and Nick about long-term wealth-building and the importance of having a flexible, tax-efficient financial tool for their futures.
  • Cash Value Life Insurance Contributions:
    • Jill pays the premiums on these policies through the FMC, which is another business expense deduction. As the cash value accumulates, it provides them with another way to build wealth outside of traditional savings and investment accounts.

Jill initially considered using 529 college savings plans for Ben and Nick but chose against it after researching the implications. While 529 plans are a popular way to save for college, Jill discovered that the funds in a 529 plan would be reported on the FAFSA (Free Application for Federal Student Aid). After consulting with a financial expert, Jill realized that contributing to Roth IRAs and cash value life insurance policies offered more flexibility and avoided the potential reduction in financial aid that 529 plans might cause. Both of these options allow her sons to save for college without the negative impact on future financial aid.

Summary of Benefits for Jill and Her Sons:

• Tax Savings for Jill:
  • Jill can deduct $24,000 in wages paid to Ben and Nick from her business income, significantly reducing her taxable income.
  • The wages are paid to her sons, who are taxed at a lower rate than Jill, reducing the overall tax burden for the family.
  • By using the family management company, Jill can maximize tax efficiency and lower her self-employment tax liability.
• Wealth Building for Ben and Nick:
  • Roth IRAs: Ben and Nick each contribute the maximum amount to their Roth IRAs, benefiting from tax-free growth.
  • Cash Value Life Insurance: Jill sets up cash value life insurance policies for her sons, offering them another tax-efficient wealth-building tool.
  • Flexible Savings: Both the Roth IRAs and the life insurance policies offer Ben and Nick flexible ways to save for college and future financial needs without worrying about taxes on growth or it negatively impacting how much college aid they qualify for some day.
• Overall Impact:
  • Jill’s family management company allowed her to reduce her tax liability, provide her sons with valuable financial education, and help them build wealth for their futures. By choosing the right combination of savings strategies, Jill ensured that Ben and Nick would have the resources to pay for college and set themselves up for long-term financial success, all while minimizing taxes along the way.

Jill’s decision to create a family management company not only helped her business but also positioned her sons for a financially secure future.

Final Thoughts

A family management company can be a powerful tool for tax savings, especially if you own multiple businesses or rental properties. By strategically structuring your FMC, you can maximize deductions, shift income, and potentially reduce your overall tax liability. However, it’s important to work closely with a tax advisor to ensure everything is set up properly and legally. With the right guidance, an FMC can help you save money and streamline your tax strategy.