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.