Give them a discount for crying out loud!
I can't tell you how many times I've had other photographers tell me that they don't give discounts to ANYONE. They don't want to be taken advantage of by their friends and family. Well, duh! No one wants to be taken advantage of, but giving your family members a discount seems like a natural thing to do. Just make sure it's a discount and not a freebie. Okay, maybe give your MOM a freebie, but not every cousin, great-aunt, or brother-in-law. The important thing here is not the discount per se, but the fact that you keep it professional. Don't skip the contract, and clearly state the exact amount of the discount you are giving them. They will appreciate seeing it in writing and it takes the awkwardness out of the situation. I always just say that the contract is for insurance reasons or book keeping purposes or something equally serious sounding.
Treat family and friends the same as any client.
For me this translates as acting a little more professionally and setting a time limit. I love shooting my very hip and cool niece. I could spend all day with her scouting locations and having fun. And there is a time for that. However, when her mom asked me for a birthday session we treated it as a session. She paid for my time and I planned the session as I would any other. We spent the hour on it that I would spend with anyone else and we stayed on task for that hour. We consulted beforehand and got the poses and locations that she wanted. It was a very successful session. I edited her images in a timely manner and delivered the final product in the same time frame that I would anyone else. One of the problems with freebies is the feeling that you need to get all of your paid sessions delivered before you start on the non-paid work. This leads to frustration and hurt feelings. And maybe those nasty feelings of being taken advantage of.
Set aside time just for family and friends.
Something that has worked for me is to set aside specific days for discounted sessions. Sometimes I open up a Saturday and let my family and close friends know that I will have session times available that day just for them. I don't usually shoot on weekends so I know there won't be conflicts with regular clients. Maybe you do it once a month or once a quarter.
Treat your business like a business.
If you don't take yourself seriously your friends and family won't either. If you owned a retail shop and sold a product I seriously doubt your sister would walk in and expect you to hand over free stuff. I guarantee she would expect a small discount or free gift wrapping, but not for you to just hand the goods over. Your time and talent are your product. It's your living. If your loved ones are not willing to pay you for your efforts, feel free to refer them to another photographer. There is no shame in that!
I know working with friends and family can be awkward. Believe me, I've been there and done that. Communication is important. Make sure that everyone understands from the very beginning that you want to work with them. You want to deliver your very best product and services to them. Be clear about the services you will provide and for what price. Follow your own rules for your business and your relationships and everyone will get along just fine!