Theory-of-mind (ToM) ability is foundational for successful social relationships, and dependent on a neurocognitive system, which includes temporo-parietal junction and medial prefrontal cortex. Schizophrenia is associated with ToM impairments, and initial studies demonstrate similar, though more subtle deficits, in unaffected first-degree relatives, indicating that ToM deficits are a potential biomarker for the disorder. Importantly, the social consequences of ToM deficits could create an additional vulnerability factor for individuals at familial high-risk (FHR). However, behavioral studies of ToM are inconsistent and virtually nothing is known about the neural basis of ToM in FHR or the relationship between ToM and social functioning. Here, FHR and nonFHR control participants underwent fMRI scanning while reasoning about a story character's thoughts, emotions, or physical appearance. Afterwards, participants completed a 28-day online 'daily-diary' questionnaire in which they reported daily social interactions and degree of ToM reasoning. FHR participants demonstrated less neural activity in bilateral temporo-parietal junction when reasoning about thoughts and emotions. Moreover, across all participants, the degree of neural activity during ToM reasoning predicted several aspects of daily social behavior. Results suggest that vulnerability for schizophrenia is associated with neurocognitive deficits in ToM and the degree of deficit is related to day-to-day social functioning.