Research consistently demonstrates that schizophrenia patients have theory of mind (ToM) impairments. Additionally, there is some evidence that family members of schizophrenia patients also demonstrate impairments in ToM, suggesting a genetic vulnerability for the disorder. This study assessed ToM abilities (i.e., sarcasm comprehension) in schizophrenia patients and their first-degree biological relatives during video-taped social interactions, to be representative of real-world interactions and to assess for disease-specific and/or genetic liability effects. Additionally, we assessed whether ToM abilities predicted social and global functioning in schizophrenia patients, and whether symptoms were associated with ToM deficits. Schizophrenia patients demonstrated impairments in sarcasm comprehension compared to controls and relatives, whereas relatives showed intact comprehension. Symptoms of schizophrenia significantly predicted worse ToM abilities. Furthermore, in schizophrenia patients, impaired ToM reasoning predicted worse social and global functioning. Given schizophrenia patients demonstrated impairments in ToM reasoning in a task that resembles real-life interactions, this might be a key area for remediation.