Saturday, January 12, 2008

The Many Advantages of Hiring Your Spouse

Oh man. The rumors are flying. The “Small Business and Work Opportunity Tax Act of 2007” has stirred up a lot of indies. Confusion reigns about how this legislation impacts a husband-and-wife working relationship. Is opportunity really knocking?

There are several posts on my blog about how best to set up a business when husband and wife have a joint venture or when one spouse helps the other. I’m now going to explain those husband-wife arrangements in detail that goes beyond previous posts. It’s somewhat complicated though, so don’t listen to White Stripes and read this at the same time.

Here are some excerpts of questions I've received.
From Cliffside Park, NJ:
I have a question regarding hiring a spouse. You advise doing it...however, don't you have to pay for their FICA and Medicare? Also, how is it beneficial to one to do this? How do you get health care insurance for them and also get it for yourself?

A graphic designer from La Center, WA:
I have been self-employed for 33 years, and most of that time my wife has helped me (proof reading, accounting, taxes, etc.) while she was also teaching. Now she has left teaching and I want to take advantage of the new husband and wife partnership clause in the 2007 tax laws. But I am not sure how to do that or if it is better than taking her on as my employee. She is only 56 and wants to continue earning social security credits.

Website designer from Rio Rancho, NM:
I found a discussion online that states that if you live in a community property state and you're in a 50/50 husband/wife partnership SE taxes won't apply to one spouse if they have another job? Am I getting this right? I live in New Mexico which I read is a community property state and I was thinking about going into a partnership with my husband. I wanted to establish my web design business as an LLC and I would be doing 100% of the work. My husband has his own separate career which he loves and has great health care so employing him instead is not really a consideration. If we established a 50/50 partnership would only my half of the income be taxed instead of his too since we live in a community property state? Or would it be best to go solo?


Let’s look at a few scenarios based on situations of my own clients.
1. Husband and wife work jointly and equally, although each has unique skills, in a business that specializes in the IT implementation of a specific software for hospitals.

2. Husband is a technical producer for television and writes about and consults on electronics for live performances, schools, and the environment. Wife is a researcher, editor, writer in the same field.

3. Wife is a sculptor and husband builds her display cases, does all her recordkeeping and manages her show schedule.

Think of the first scenario as a 50/50 work split;
The second as the husband’s share is 70% and the wife’s is at 30%;
The last as the wife at 80% and the husband at 20%.

In each of those work relationships the structure that is the most tax-advantageous, the least complex, and costs the least in accounting fees is: One spouse has a sole proprietorship business with the other spouse as employee.


Tax situation
I’m going to use scenario #3 -- the 80/20 split -- to explain the tax advantages. If the sculptor has a net self-employed income of $50,000 and from that she pays her husband wages of $10,000 for his services, then they are simply moving the $10,000 income from one place on the tax return to another. There is no savings of income tax. And there is no savings in SE tax. (Remember, SE tax is Medicare and social security tax, also known as FICA.) The husband’s wages from his wife’s business count toward his social security credits.


Tax advantages
*** If the husband has already paid the maximum social security (that was $97,500 in 2007) through his regular job he will not have to pay social security tax on the wages paid to him by his wife.


*** The wife may provide him and his family with medical, and dental coverage. If he already has coverage through his job she may provide him with supplemental coverage. Or if coverage from his job does not include his spouse and/or children, she can fill that gap with additional coverage. These are business deductions for the wife and not taxable to the husband.
The insurance may be in the name of either spouse. It does not have to be purchased by the business or in a business name. You may keep the medical insurance you already have.

*** The wife may provide the husband with life insurance. Premiums are deductible from her business .

*** She may give her husband-employee a pension. The tax savings from this could be substantial depending on the type of pension and whether her husband has pension coverage at another job, also whether they have extra money to contribute.
Hubby may contribute his entire salary toward his pension. In this example, that would mean that the $10,000 she paid him is not taxable income. And wife-employer may contribute an additional very large employer’s share toward her husband’s pension. That, too, is a deductible business expense.

*** Were he not her employee and he accompanied her on a business trip, as helper, they could not deduct his travel expenses. As her employee, the husband’s expenses are her business deductions.

*** An employer-employee relationship simplifies the deduction of many business expenses, especially auto and home office.


Complexity and Accounting Fees
Tax preparation for a sole proprietorship is part of your individual tax return.

Recordkeeping for a sole proprietorship is easier than for any other business structure. Remember, a sole proprietorship may be an LLC. Read about it here
Sole Proprietor as an LLC


Now, what about that Tax ACT ?
If a husband and wife jointly own a business and the business is not incorporated they do not have to file a partnership return. They may file as a sole proprietorship, using a Schedule C as part of their personal tax return. They split the income and the SE tax based on each one's share of income.

Prior to January 1, 2007 only those who lived in a community property state could file as solos. A husband-wife business in other states had to file as a partnership.

So if a couple were to have a 50/50 business with a net income of $50,000 then each would pay tax on $25,000. There is no income tax savings. If either spouse were over the maximum for social security tax then that spouse would not pay SE tax on his or her self-employed income.

To answer the questioner from Rio Rancho: The Tax Act states that in order to split the income each spouse must materially participate. “Materially participate” means that each spouse must do some of the work. If the wife has no connection to the business but has met the social security maximum via another job don’t get crafty by saying that this business is 95% the wife’s and only 5% the husband’s. The beady-eyed IRS will see this as just a ruse to avoid SE tax. It’s a bad idea.

OK. Now you may listen to White Stripes.

7 comments:

Anonymous said...

Hello, My husband needs one more quarter of social security to qualify for benefits. He is 65, and a retired federal employee with an annuity from the Office of Personnel Management. We visited the soc sec office yesterday with the intent of signing up for Medicare and getting more information about what social security benefits he would be entitled to. They encouraged him to get a job, make $1,050 by Dec 2008, thus earning the last of the required full 40 quarters to quality, and then come in to file. Because of the laws regarding Federal pensions (the Windfall provision) he will only be entitled to $125.30/mo. of Social Security benefits. Medicare Part B, which he signed up for yesterday, costs $122/mo (the base rate for part B is actually lower than that but we pay the higher rate because of our income level). So the Soc Sec rep suggested pursuing getting a job and earning at least $1,050 before Dec 31 2008, thus qualifying for benefits so that it would cover this Medicare payment.
In addition to working at a full time job, I also am a sole proprietor of a business that helps very small businesses update their computer technology, do workflow analysis, and train staff. I mostly work with small shipping, warehouse and logistics providers as well as doing space planning for corporate moving companies.

I want to hire my husband for a project researching warehouse management systems for small business, and their costs and advantages,and providing me with a report that I can then give to my customers. I would pay my husband approximately $1200 or about the same that I would if I were hiring an outside consultant to do the work. I file IRS 1040 Schedules C and SE each year with our joint return. Finally here is my tax question - can I hire my husband as a consultant, then on our joint 1040, include a a Sch C-EZ and Sch SE form for him, and thus pay the Soc Sec/Medicare payments on that $1200 as part of our tax?
Thank you if you get a chance to reply to my question or for any help you can lend. I am trying to read through the IRS regulations now but it would be helpful to hear your advice on this subject.
Thanks again!

June Walker said...

Clever idea, but obvious to anyone who looked at the situation that your husband is not a legitimate self-employed in business for himself.

If you do need help in your business you may certainly hire your husband as an employee.

That would give him the needed income and you the help you need. An added advantage: You may keep him on payroll after he's met the minimum social security requirements and his social security benefits will grow.

-- June

Anonymous said...

Thank you for your response and comment. I neglected to mention in my question -- my husband actually IS a legitimately self-employed consultant. I ordinarily do a Sch SE and C-EZ for him but this time the income would be coming from me, his wife, as the employer, and I wanted to make sure that it was totally legal to hire him as a consultant and to report the income as I'd mentioned in my previous post.
Thanks again!

June Walker said...

Again to Anonymous --

If you hire a consultant to work as a self-employed you are not his employer. You are simply hiring an independent contractor to work for you.

An employer hires employees.

A business owner may hire both employees and indies.

-- June

jqs said...

I've been doing a lot of reading about this and I think you captured the benefits very clearly (and in the fewest words yet). I have one question about this arrangement that has so far eluded me.

I'm a sole proprietor. I have an Individual 401k. I can put 16.5k+20% net income into the 401k (up to ~49k for 2009). If I hire my wife and she sets up her own Individual 401k as a result, do we split the 20% net income? If I was incorporated, it would be easy... 25% of each person's compensation... but I'm not clear how the 20% of net income gets distributed.

June Walker said...

Hi jgs,

To oversimplify and leaving out all the caveats and nuances: You, the employer of your spouse, would set up a SOLO-k [same as a 401-k pretty much] for her. If over 50 she may contribute up to $16,500 of her wages from you.

You, the employer, then contribute an additioanl 25% of her wages.

-- June

Jesus said...

Hi there, very interesting post. Now what if the family income coming from an LLC is above 100,000? Say 120,000. Wouldn't splitting the income between the husband (member) and wife(employee) 70/30% impose more of a SE tax burden on the family? I mean because the husband wouldn't thus reach the limit for SE tax. I can't seem to find this info anywhere. What's your opinion? Thx a million.