Schizophrenia patients have impaired performance and abnormal brain activation during facial emotion recognition, which may represent a marker of genetic liability to schizophrenia. However, it remains unclear whether the impairment is specific to recognizing emotion from faces or is instead attributable to more generalized dysfunction. The current study aimed to distinguish between specific and generalized neural dysfunction underlying impaired facial emotion recognition in schizophrenia and examine associations with genetic liability. Twenty-eight schizophrenia patients, 27 nonpsychotic first-degree relatives, and 27 community controls underwent functional magnetic resonance imaging while making judgments about either the emotion or age of emotional faces. Patients had performance deficits during the emotion and age discrimination conditions compared to relatives and controls, while relatives had intact performance. Patients had hypoactivation compared to controls across conditions, mainly in medial prefrontal cortex. Unlike controls, patients demonstrated a failure to recruit the dorsomedial prefrontal cortex, a region involved in social cognition and decision-making, and relatives had a pattern of recruitment intermediate between patients and controls. Compared to controls, relatives had greater deactivation of regions associated with the default mode network, and patients had similar findings during age discrimination. The common patterns of performance deficits and activation abnormalities during emotion and age discrimination in schizophrenia suggest that generalized cognitive impairment, notably in social cognition and decision-making, contributes to impaired facial emotion recognition. Similar functional activation patterns in relatives, despite intact performance, suggest that brain activation may represent a more sensitive marker of genetic liability than behaviour. Hyperdeactivation of default mode network regions in relatives may represent cognitive inefficiency, or compensatory mechanisms that help maintain intact performance.