Many married couples work in their business together and sometimes one spouse works for no pay or benefits, But, if your spouse works on a regular basis as an employee, you might consider putting your spouse on the payroll as an official employee, for several reasons. There are some advantages - and disadvantages - to classifying your spouse as an employee.
Putting Your Spouse on the Payroll
If you have a spouse who wants to help out and you have enough money coming in from the business and other sources, it might be tempting to have the spouse work in the business but not as an employee.
Your spouse may also be a part-owner of the business, and he or she may receive dividends (if the business is a corporation) or a share of the net income from a partnership or LLC. In this case, if your spouse works on a day-to-day basis in the business you may decide not to pay a salary to this person in addition to the money received as an owner.
Employee or Owner? How the IRS Sees It
If one of you controls the business and makes management decisions and the other spouse is under the direction and control of the other, the IRS sees this as an employer-employee relationship.
But if both of you have an equal say in the business, you provide "substantially equal" services to the company, and you both contribute capital to the business, the IRS sees this as a partnership, and you must pay tax as a partnership, even if you don't have a formal partnership agreement.
Social Security Credit for Spouses as Employees
If your spouse works in your business for no pay, he or she doesn't accumulate credit towards Social Security. But hiring your spouse as an employee means that he or she will receive Social Security credits toward receiving a Social Security income at retirement. Of course, this also means that FICA tax (Social Security/Medicare) will be withheld from your spouse's pay and that the business will also have to contribute to this account.
Spouse-Employee and Payroll Taxes
In addition to withholding and paying FICA taxes based on your spouse's income, you must also withhold federal and (if applicable) state income taxes from your spouse's paychecks. But, you don't have to pay unemployment insurance for your spouse.
If your business has a retirement (defined contribution) plan that's qualified by the IRS, your working spouse/employee can receive retirement benefits. Your business's annual contributions to the plan and other additions (excluding earnings) to a participant's account can't exceed the lesser of the following amounts.
- 100% of the participant's compensation.
- $55,000 ($56,000 for 2019).
Health Insurance Coverage for Spouse/Employees
If your business provides health insurance coverage to employees, you may find it cheaper to cover your spouse as an employee rather than as a dependent under your coverage as an employee/owner.
The cost of company-paid premiums for your spouse's health insurance is deductible to the company and your company's payments are not considered wages and are not subject to Social Security, Medicare, or federal income tax withholding.
You may also want to look at the impact of hiring your spouse on the health care tax credit available to small businesses that pay for health insurance for employees.
Business Travel With Spouse/Employees
If your spouse/employee has a legitimate reason to travel with you on business trips, you can deduct your spouse's travel costs as a business expense, but only if:
- Your spouse is a paid employee, and
- Your spouse has a business purpose for being on the trip.
You must be able to justify the reason for your spouse to accompany you on a business trip as an employee. The reason should relate to your spouse's position with the company. "Holding your luggage" doesn't count as a legitimate reason for your spouse to go on this trip as an employee, but if your spouse is marketing manager and you are going to a trade show, this could be legitimate.
Life Insurance and Other Benefits for Spouse/Employees
Your spouse/employee can receive any benefits given to other employees, including employer-provided life insurance. Premium costs up to $50,000 of group term life insurance are not taxable to employees and are deductible as a business expense.
What Are the Drawbacks of Treating My Spouse as an Employee?
The principal cost of treating a spouse as an employee are the costs of any employee. These employee costs include:
- costs of employment taxes, including the amount of FICA tax that must be paid by your business.
- costs of providing employee benefits to your spouse, including costs for putting a spousal employee on the company health care plan.
Of course, these costs are deductible as business expenses by the company.
If your business is a corporation, consider the difference between your personal tax bracket and the corporate tax bracket when weighing the effect of hiring your spouse as an employee. In other words, look at the difference between the income to your spouse as an employee vs. costs to the corporation of hiring and paying.
A potential drawback may also be issues that arise in the event of a divorce. If your spouse is working in your company and you decide to divorce, check with your tax advisor and attorney about potential issues that may need to be resolved.
Treating Your Spouse-Employee Like Other Employees
If you decide to put your spouse on the payroll as an employee, you must treat him or her as an employee in every way:
- Give your spouse a title and an appropriate salary for that title.
- Have your spouse complete all the required new hire forms and payroll authorizations, the same as any other new employee. Read more about the new hire forms you should have your spouse complete.
- Make all required deductions and withholding from your spouse's pay, including withholding federal income tax and making FICA deductions.
- Include your spouse/employee in all benefits coverage provided to other employees.
- You should be able to prove that your spouse is actually doing the work for which he or she is being paid.
- If your spouse is also an officer or owner of your business, keep the salaried duties separate from any ownership activities.
Special Circumstance: S Corporation Owners
If you and/or your spouse own more than 2% of an S corporation, some of the benefits of "spouse as an employee" may not be available to you or they may be different.
Disclaimer: This article is intended to provide general information and is not intended to be tax or legal advice. Every situation is different, and tax laws change. Before you hire your spouse as an employee, discuss your specific situation with your tax and legal advisors.