5 Things to know about Employing your Spouse
Hiring your spouse to work as an employee in your business can save you big on taxes. (yay!)
But this arrangement can backfire if you don’t do it the right way.
Here are 5 key things to know about employing your spouse.
1. Pay Your Spouse Tax-Free Employee Benefits, Not Taxable Wages
Don’t put your spouse on t he payroll. this only means your are moving money from one column to another on your tax return.
In other words, this doesn’t help you because your are still paying taxes tot he IRS for their wages.
Instead of wages, you should pay your spouse entirely, or mostly, with tax-free employee fringe benefits. (Every spouse loves a fringe benefit!) Certain employee benefits, such as health insurance, are not taxable income for your spouse-employee, yet they are a deductible expense for you as your spouse’s employer. This results in a real tax savings.
Also, if you pay a spouse only with tax-free fringe benefits, you need not pay payroll taxes, file employment tax returns, or file a W-2 for your spouse.
But don’t you have to pay your spouse at least the minimum wage, which must consist of cash wages? No, you don’t.
In most states, the minimum wage laws don’t apply when a sole proprietor business owner hires his or her spouse as an employee. The same holds true for federal and state unemployment taxes.
If your business is a corporation or an LLC, the minimum wage laws do apply when your business entity, not you as an individual business owner, hires your spouse. Minimum wage laws are not enforced by the IRS. You need not pay your spouse any cash wages to deduct employee fringe benefits you pay him or her. The only requirements are that your spouse is your bona fide employee and that the total compensation you pay is reasonable.
Some business owners pay their spouse a nominal amount of wages in addition to fringe benefits—for example, $1,000 per year or $100 per month—and file a W-2. But if your spouse is not your bona fide employee, paying such a small amount of wages won’t be much help.
2. Establish a Medical Reimbursement Arrangement
Health benefits are normally the largest tax-free employee fringe benefit you can provide your spouse.
By hiring your spouse and adopting the right type of plan, you convert health insurance premiums and other medical expenses for your spouse, yourself, and your children under age 27 into fully deductible business expenses. (Just make sure you have the right plan.)
Deducting these health expenses as a
business deduction reduces your taxable income not only for income taxes, but for Social Security and Medicare taxes as well.
If your spouse is the only employee of your business, you should establish a spousal health reimbursement arrangement. This is the best possible way to pay for health expenses when you own your own business.
With only one employee, your 10
5-HRA is not subject to Affordable Care Act (ACA) restrictions, which prohibit stand-alone HRAs.
Here’s how it works:
- Your spouse purchases a health insurance plan in the spouse’s name to cover the entire family (including you). You, as the employer, reimburse your spouse for the premiums.
- You reimburse your spouse for health expenses not covered by insurance, including deductibles, copays, and prescriptions, for your entire family.
The IRS imposes no limit on the amount you can reimburse a spouse-employee with a 105-HRA. The entire cost is a tax-free employee fringe benefit for your spouse.
Meanwhile, you (the employer) get to deduct the full amount as an ordinary business expense for an employee benefit program.
Win-Win!
This arrangement works under various types of businesses such as:
- a sole proprietorship reporting on Schedule C of IRS Form 1040;
- a partnership filing IRS Form 1065;
- an LLC taxed as a sole proprietorship or partnership;
- a real estate rental business reporting on Schedule E of Form 1040;
- or a farm business reporting on Schedule F of Form 1040.
Fear not for those of you who have more that one employee there is another solution for you.
Instead, you may establish an Individual Coverage Health Reimbursement Account (ICHRA) to cover your spouse and other employees.
ICHRAs are new—they be
gan on January 1, 2020. They offer many of the same advantages as 105-HRAs. With an ICHRA, your spouse and other employees obtain their own individual health coverage or Medicare. Your spouse’s plan should include you and other family members.
Your employees must prove they have coverage each year.
You, as the employer, set a monthly allowance of tax-free money your spouse and other employees can use to pay for their health insurance premiums and other uninsured health care expenses.
The IRS imposes no caps on the allowance—it can be as big or small as you specify. You are even allowed to discriminate among your employees, and to provide some classes of employees with better benefits than others. For example, you may provide larger reimbursements for full-time employees than for part-timers. The reimbursements are tax-free to the employees and tax-deductible for you, the employer.
(ICHRA for the win!)
Neither the 105-HRA nor the ICHRA works if your business is an S corporation. When you own more than 2 percent of an S corporation, your spouse is not considered your employee and therefore cannot participate in employee health plans. (Sorry if your an S-Corp)
3.Take Advantage of Certain Other Fringe Benefits
There are other tax
-free employee fringe benefits you can provide your spouse, as follows
Education. Job-related education f
or your spouse-employee is deductible by you and not income to your spouse employee. (But beware of Section 127 education programs, as you’ll see below.)
Life insurance. Employers may provide employees up to $50,000 in group term life insurance coverage tax-free
Working condition fringe benefits. These are expenses for items that help your spouse do his or her job. For example, you can deduct the cost of a smartphone your spouse uses for business purposes.
De minimis fringes. Certain types of relatively low-cost occasional employee benefits are tax-free and deductible by the employer. These include occasional meals and snacks, gifts (such as a small birthday gift), sporting event or theater tickets, and flowers or fruit for special occasions
4. Beware of Certain Tax-Free Benefits
Section 127 education plan. The law prohibits Section 127 benefits to your spouse and dependents under the 5 percent ownership test.
Transportation benefits. If you and your spouse work in an outside office, you can provide him or her tax-free transportation benefits—just as you can for any rank and file employee.
For 2020, you may pay up to $270 per month for parking near your business premises or for transit passes. But as a result of the TCJA, the tax-free transportation benefits to your employees are not deductible by you, the employer. Because we are talking about your spouse as an employee, the transportation fringe benefit gives no net benefit to you and your spouse. (So not so much a Win.
5. Make Sure Your Spouse Is Your Bona Fide Employee
The IRS usually attacks spouse-employee deductions for health insurance and other expenses by claiming the spouse is not a bona fide employee.
Instead, you need to be able to prove the following.
Your spouse is not a co-owner of your business.
- Spouses who co-own a business are engaged in a partnership, not an employer-employee relationship.
- Your spouse should not share title in any business assets.
- You should have a separate business bank account under your sole control.
- All contracts and government filings should be in your name alone.
Your spouse does real work.
- Your spouse must perform real work for your business, whether full or part time.
- The services don’t have to be indispensable—only common, accepted, helpful, and appropriate for your business.
- Keep track of the work your spouse performs and the related hours.
- The time sheet should list the date, the services performed, and the time spent performing the services.
- The time sheet is the key to proving your spouse is a real employee.
Your spouse gets paid.
- Your spouse should pay all medical and other reimbursable expenses from their own separate checking account, and then submit a claim for reimbursement.
- You then pay the reimbursement from your business account, and your spouse deposits it in his or her checking account.
Your spouse works under your direction and control.
- The IRS uses the common-law “right of control” test to determine whether your spouse, or any other worker, is your employee.
- You should make the management decisions, and your spouse should work under your direction and control.
Sounds antiquated, but that is the best way for you to prove to the IRS your spouse in an employee and not a controlling member.
Your spouse’s compensation is reasonable.
- Your spouse’s compensation must be reasonable to be deductible. (So no paying your Spouse $50,000 to sort the mail)
- Pay no more than similar workers earn for similar work.
Key point. Comply with state requirements for employers. Depending on your state, you may need to register as an employer and provide your spouse with workers’ compensation coverage even if he or she is your only employee. In a few states, you may also have to withhold and pay premiums for state disability or family and medical leave programs.
The long and short of it!
Hiring your spouse can result in substantial tax savings, but only if you pay your spouse solely, or mainly, with tax free employee fringe benefits instead of taxable wages.
The most valuable fringe benefit you can provide your spouse-employee is reimbursement for health insurance and uninsured medical expenses.
Tax-free employee fringe benefits may also include certain education, life insurance, and working condition fringe benefits.
You must be able to show that your spouse is a bona fide employee.
To do so, your spouse should:
- use a time sheet to keep track of the work performed;
- be regularly paid a reasonable amount;
- work under your direction and control;
- and not be a co-owner of your business.
For more information on this article and many more to help your business grow contact us!