Integrating non-family members into your family business can present a number of challenges. After all, most family businesses have deep-rooted traditions and values, and introducing an outsider can be unsettling and stressful. From finding the right fit, integrating them into your culture, and ensuring your taxes and accounting stay in order, there’s a lot to consider.
In this blog, we’ll break down all the essentials of hiring non-family members. That way, you’ll have all the hard facts you need to make the right decision, without the stress.
Considerations for Hiring Non-Family Members
Bringing new talent into your family business isn’t always a straightforward decision. For starters, it can be tough to decide on who to bring in. Should it be that college graduate with no experience but a promising future, or someone who already has years of experience but may shake up how your business does things? And then there are the more practical considerations, like how new hires can impact your business values, financial goals, and succession plans.
Because of these kinds of questions, it’s best to start by examining the potential benefits of hiring non-family members. For example, such hires may come with specialized skills and experiences that can be invaluable to your business. After all, diverse professional knowledge is crucial for growth and competitiveness. It means you’ll be able to implement formal processes, structures, and governance mechanisms to streamline operations, reduce costs, and improve overall efficiency.
At the same time, non-family members can bring an objective perspective to your business. This can help lower the risks of emotions influencing strategic decision-making. They’ll be able to help you determine whether your choices are for the best of the business without being swayed by family ties. This objectivity can also help with growth and innovation, through the introduction of new ideas, technologies, and practices. That way, you can ensure that your family business can evolve and adapt to remain competitive.
You’ll also need to assess the impact of these additions. Remember that non-family members can significantly impact your business culture. Hiring outsiders can lead to a more diverse and inclusive workplace, with an emphasis on merit and professional input rather than hierarchy. However, this means you’ll need to carefully manage this integration to ensure that your family does not feel overlooked or, while new hires don’t feel like the bad guys.
Compensation Strategies for Non-Family Members
Once you’ve decided to bring on a new hire, the next important consideration is how much you should pay them. But how do you determine fair yet competitive compensation? Start by checking the standards for your industry. Research salary data from your competitors and those businesses with similar structures as your own. You’ll need to ensure that your pay scales are in line with or a little bit higher than market rates. That way, you can attract top talent, and ensure that you can meet their salary expectations.
Alternatively, you can consider implementing a performance-based compensation model. Consider, for instance, bonuses based on individual and company performance, to ensure that all employee interests align with your business’ success.
Another aspect to consider is long-term incentives, like stock options or profit-sharing. These have the dual purpose of rewarding your employees for their hard work and commitment, while fostering a sense of ownership and loyalty to your business.
Balancing internal equity
One of the most important considerations with regard to remuneration is to ensure equity between family and non-family members. Without this, you run the risk of decreased employee morale and an increased potential for conflict.
To ensure all employees are satisfied with the offered pay scales, you must establish transparent compensation policies. These must outline how pay is determined for your staff, based on factors like their experience, performance, and general market value. What you pay for a specific role should be based on job responsibilities, the required skills, as well as how the position contributes to the business. That way, you will not have to worry about being accused of paying a staff member based on their status within your family.
Alternatively, you could consider different compensation structures for family or non-family members. For example, some businesses ensure that family members get dividends or ownership compensation, while non-family members are paid strictly according to their professional titles and responsibilities. If you consider a similar setup, such differences must be disclosed and clearly communicated from the start, to avoid any conflict down the line.
No matter how you decide how much to pay to whom, remember that different methods of compensation can have varying tax implications, both for your employees, and your business.
Tax Considerations in Hiring and Compensation
If you’re considering hiring external talent for your family business, there are several important tax considerations to keep in mind, both compliance and for your company’s financial health.
To start with, no matter who you hire, or the responsibilities they must perform, all your employees must be correctly classified as employees or independent contractors. Misclassification can lead to significant tax liabilities, including steep penalties. Note that independent contractors are basically responsible for their own tax filings. However, you are responsible for handling payroll taxes for employee salaries, as well as for withholding and remitting employee income tax. Thankfully, salaries are typically deductible as a business expense, which can reduce your taxable income.
Similarly, any bonuses you may pay are considered ordinary income and are also taxed like salaries. And then there’s non-cash benefits, like retirement contributions or health insurance. These can provide your business with tax advantages. For example, your contributions to staff retirement plans are usually deductible.
Navigating employment taxes and withholdings
When it comes to handling your employee salaries, your business is responsible for paying the employer portion of payroll taxes. This includes 6.2% for Social Security and 1.45% for Medicare taxes (FICA), 6% for unemployment taxes (FUTA). You may also need to pay state employment taxes. Each state has its own regulations and rates, so it’s important to keep up to date with all requirements to avoid fines or penalties.
You must report your paid salaries and the associated withheld taxes on Form W-2 and 1099-NEC, for employees and contractors, respectively.
Because employee compensation can have such a large impact on your payments, it needs to be carefully considered as part of your business’ overall tax strategy.
Equity Sharing with Non-Family Members
Equity sharing essentially involves offering a stake in the company to non-family employees or partners as a form of compensation. By offering your employees company shares, you incentivize your staff to ensure your business performs well. After all, as shareholders, your employees are personally invested in the company’s share price and performance, through aligning everyone’s interests.
But this isn’t the only benefit of such plans. Offering equity can also improve employee retention, and act as a magnet for talent attraction.
Equity sharing models
There are several different ways to go about equity sharing. This includes:
- Stock Options: Here, a staff member purchases shares at a predetermined price, which is usually below market value. These are usually granted as part of a compensation package. Moreover, they offer tax benefits, because taxes on these plans are deferred until the shares are sold.
- Restricted Stock Units (RSUs): RSUs are awarded as a promise of future shares after certain performance milestones are reached, or after your employees have worked for a designated amount of time. They’re considered a form of deferred compensation. This means that employees can access company equity without investing their own money or resources. However, RSUs come with significant tax consequences.
- Phantom Equity Plans (PEPs): These allow employees to receive a payment based on the value of the company’s stock without actually owning any shares. Your staff are therefore given mock or “phantom” stock, based on the value and performance of your company’s real shares. These are typically paid out in cash. As such, they’re easier and cheaper to manage. Also, you’re not responsible for withholding taxes on the payments.
Tax implications
Remember that equity compensation has specific tax implications and must therefore be managed carefully. According to the IRS, stock options are considered IRC section 401(a) qualified defined contribution plans. This offers a few benefits. For example, cash and stock contributions to such plans are tax-deductible, as are contributions used to repay any loans taken out to purchase shares.
No matter what type of stock you offer, it needs to be transparently disclosed on your financial statements, according to generally accepted accounting principles (GAAP) and ASC 718-10-50-2(d). The cost of stock-based compensation must be recognized as an expense on your income statement. This expense is typically recognized over the vesting period of the equity awards.
Legal and Regulatory Compliance
When hiring non-family members into your family business, you must be mindful of the numerous legal and regulatory requirements at the federal, state, and local levels. These include:
- The Fair Labor Standards Act (FLSA), which governs minimum wage, overtime pay, and record-keeping requirements. Ensuring compliance with this Act means accurately tracking hours worked and calculating appropriate wages, directly affecting payroll taxes.
- The Family and Medical Leave Act (FMLA) mandates job-protected leave for qualified medical and family reasons.
- Anti-discrimination laws, such as the Civil Rights Act and the Americans with Disabilities Act (ADA), ensure equal employment opportunities and prohibit discrimination.
On top of this, you need to ensure that your family business complies with Occupational Safety and Health Administration (OSHA) regulations. These help you determine whether your company provides a safe working environment for its employees. This encompasses safe facilities, proper training, and how to avoid and handle workplace injuries.
Compliance also extends to your employment contracts and employee paperwork. This includes staff working hours, overtime pay, and records. One way to ensure this aspect of compliance is to have clean employment contracts. You’ll also need to establish and enforce policies for areas such as attendance, performance evaluations, disciplinary procedures, and workplace conduct. If you’re in doubt, consult an expert.
We can help
At Fusion CPA, we have assisted family businesses across the country with integrating new employees and scaling their operations. To see how we can help your family business, schedule a Discovery Call with one of our CPAs.
The information presented in this blog article is provided for informational purposes only. The information does not constitute legal, accounting, tax advice, or other professional services. We make no representations or warranties of any kind, express or implied, about the completeness, accuracy, reliability, suitability, or availability of the information contained herein. Use the information at your own risk. We disclaim all liability for any actions taken or not taken based on the contents of this blog. The use or interpretation of this information is solely at your discretion. For full guidance, consult with qualified professionals in the relevant fields.