How does your friend know that the owners aren't reporting the paid personal expenses as taxable income? It's not illegal to have the company do that as long as it's reported as income and taxed appropriately. I do understand your friend may be in a position to know that's not happening though if he's preparing the year-end W-2s.
It's not against the law to put family members on the payroll even if they don't do a day's work. As for money laundering, well, that's way out of my league to even comment on.
I suggest your friend start looking for a new job pronto. Can't understand why he's stayed there for a whole decade with this going on. And, as Lynn said, he's free to report the fraud to the federal IRS and the State IRS.