Background Studies have identified perturbations in facial processing in bipolar disorder and major depressive disorder (MDD), but their relationship to genetic risk and early development of illness is unclear. Methods The Scottish Bipolar Family Study is a prospective longitudinal investigation examining young individuals (age 16–25) at familial risk of mood disorder. Participants underwent functional MRI using an implicit facial processing task employing angry and neutral faces. An explicit facial expression recognition task was completed outside the scanner. Clinical outcomes obtained 2 years after the scan were used to categorise participants into controls (n = 54), high‐risk individuals who had developed MDD (HR MDD; n = 30) and high‐risk individuals who remained well (HR Well, n = 43). Results All groups demonstrated activation patterns typically observed during facial processing, including activation of the amygdala, hippocampus, fusiform gyrus and middle frontal regions. Notably, the HR MDD group showed reduced activation of the anterior cingulate gyrus versus both the control and HR Well group for angry faces, and versus the HR Well group for neutral faces. Outside the scanner, the HR MDD group was less accurate in recognising fearful expressions than the HR Well group. Conclusions Here, we demonstrate functional abnormalities of the anterior cingulate cortex alongside facial emotional recognition deficits in high‐risk individuals in the early stages of depression compared with both controls and at‐risk individuals who remained well. These neural changes were associated with a current or future diagnosis of MDD and were not simply associated with increased familial risk.