Employment Contracts with Spouses/Children – What Do Business Owners Need to Know?

As a business owner subject to taxation, you want to keep your tax burden as low as possible. Expenses related to employees can be claimed as business expenses for tax purposes. This makes employment contracts with family members an attractive option. For example, by hiring a family member, you can transfer income to your spouse. This way, the income would remain within the family and could still be claimed as a tax deduction. Of course, your spouse must also pay taxes. However, the family member working for you can claim all income-related expenses under the terms of their employment contract. Sound too good to be true? In fact, you have to be especially careful with employment contracts involving family members to ensure all legal requirements are met. The tax office is understandably very critical of such expenses for family members. In this article, as your tax advisors in Düsseldorf and Oberhausen, we have therefore summarized the most important aspects.

Who counts as a relative under tax law?

First, you must ask yourself who counts as a relative of an entrepreneur. Close relatives are particularly relevant here. If an employment contract is concluded with a close relative, it must be planned with particular care. Your close relatives include:

• Fiancés
• Spouses/registered partners
• Parents and grandparents
• Children and grandchildren
• Siblings
• Brothers-in-law/sisters-in-law and nieces/nephews
• Foster parents and foster children

Even if spouses get divorced or a registered partnership is dissolved, they remain “close relatives.” For engaged couples, however, the status of relative ceases when the engagement is broken off.

Consequently, you must take specific factors into account regarding many people in your circle if you wish to enter into an employment relationship with any of them.

What aspects must be considered?

If an employment contract is entered into with a close relative, various aspects must be taken into account. Even minor errors or failure to comply with regulations can lead to problems with the tax authorities during a tax audit. Therefore, it is important that you seek detailed advice from a tax advisor. As tax advisors in Düsseldorf and Oberhausen, we can also help you avoid mistakes and problems in specific individual cases.

Formal Requirements of the Employment Contract

An employment contract exists when you, as the employer, have contractually agreed with the relative (employee) on the standard and essential components of an employment contract. In doing so, the “standard” legal requirements must be observed. An employment contract may be concluded “informally.” Therefore, in theory, it is sufficient to conclude it verbally. As tax advisors, however, we would always recommend choosing the written form for evidentiary purposes.

Warning! Employment contracts must never be backdated. Any business owner who believes they can save on taxes this way must expect to face proceedings for tax evasion.

Freedom of Contract vs. Arm’s Length Principle

Employment contracts are subject to statutory freedom of contract. This means that the contract may be drafted “freely” as long as basic requirements are met. From a tax perspective, however, the arm’s length principle also applies. In this context, the family member’s employment contract is compared to a “standard” employment contract with a third party. If it is determined that the employment contract with the family member is not “normal” or appears unrealistic—for example, because only one hour of work per week is specified—the contract is considered non-deductible from a tax perspective. Thus, while the contract remains in effect, it is not recognized by the tax authorities.

Is the employment contract actually being carried out?

Many business owners assume they can simply enter into various employment contracts with relatives to save on taxes. After all, does it really matter whether the person actually works and fulfills the obligations under the contract? In fact, this is the most common mistake that leads to unpleasant disputes with the tax authorities. For the employment contract with a family member to be recognized by the tax office, the contract must be “lived out.” That is why your spouse must actually work the specified hours.

Example of a Good Employment Contract with a Family Member

Now that we have outlined some of the important basics for an employment contract with a family member, an example should help. Below, you will find a sample employment contract with a family member. This is intended solely for guidance. In individual cases, you should always consult a tax advisor or legal counsel.

Employment Contract

Between

Max Mustermann (hereinafter referred to as the Employer) and

Maria Mustermann (hereinafter referred to as the Employee), the following is agreed upon. The employment relationship begins on March 1, 2019. It is concluded for an indefinite period. The Employee works as an office assistant at the Employer’s company in Musterstadt. The duties include answering the phone, writing invoices, monitoring incoming payments, sending out reminders, and compiling the necessary documents for the tax advisor. The Employee shall receive a gross monthly salary of €1,000 for her work. The salary shall be transferred monthly on the 3rd of the month to the Employee’s sole bank account. Like every other employee in the company, Maria Mustermann also receives a monthly gas voucher in the legally permitted amount of currently €44. A Christmas bonus is paid voluntarily and amounts to half a month’s salary; it is due with the November salary. The daily working hours are Monday through Friday from 9 a.m. to 1 p.m. Vacation entitlement is in accordance with the statutory amount and amounts to 20 working days. Vacation is taken in consultation with the employer and in consideration of company needs. The first 6 months of the employment relationship constitute a probationary period. During the probationary period, the employment relationship may be terminated by either party at any time with 14 days’ notice. After the probationary period ends, the statutory notice periods for ordinary termination apply. The right to terminate without notice remains unaffected. There are no collective bargaining agreements or company agreements that would apply to the employment relationship. In all other respects, the statutory rules apply to the employment relationship (e.g., the Continued Pay Act in the event of illness). Sample City, February 12, 2019 Employer’s Signature Employee’s Signature

Help with Employment Contracts for Family Members

As mentioned earlier, as a business owner, you should always consult a tax advisor or legal counsel when drafting an employment contract with a family member. There are various special cases that we cannot address in this article. Therefore, it is easy to overlook something and make a mistake.

We want our clients to avoid problems with the tax authorities and to take full advantage of the best possible tax benefits. As tax advisors in Düsseldorf and Oberhausen, we are therefore happy to assist you in drafting an employment contract with a family member. During an initial consultation, you can ask questions and get to know our team. Just contact us today!