By Jacob A. Stewart JD
I was on the phone the other day with my client’s CPA discussing some tax deductions I felt the client could be taking. It was a productive discussion, and we found several ways to save our mutual client thousands of dollars per year in taxes. As we discussed shifting income to the kids, however, the question came up as to whether or not the business owner should add his spouse to payroll. That question comes up a lot, so I thought I would share some considerations to go through in case you have that question for your own business.
Payroll Taxes are a Killer
Bear in mind that, any time you hire someone, you have to pay Social Security and Medicare taxes on their behalf. Between your share and the employee’s share, the tax is 15.3% (part of which is deductible for your business). If you pay your spouse, your income tax doesn’t change (assuming you file jointly), but you will likely be paying 15.3% more on the amount you pay your spouse than you would pay if that income was instead business profits. The only time that would not be the case is if you lowered your salary by the same amount you paid your spouse (assuming you are already paying yourself less than $129k per year, which is the approximate cap for Social Security).
[As a side note: If you hire your kids, they may save you money in income taxes (unlike paying your spouse), but they will still owe Social Security and Medicare taxes. Fortunately, with kids under 18, you can avoid payroll taxes if you pay them through a sole proprietorship or a partnership owned by you and your spouse. If you pay them through an S-corp or a C-corp, though, they will have to pay Social Security and Medicare.]
Retirement Contributions and Other Benefits
In some cases, though, maybe you want to be able to contribute more each year to a qualified account, such as a 401k. If you maximize your contributions but want your spouse to be able to contribute more, you can add your spouse to payroll and he or she can put all of his or her income into the company 401k (up to the annual limit, of course). Bear in mind, though, that in most cases, a spouse can take advantage of a spousal IRA without having to be employed. The maximum contribution for a spousal IRA is currently $6000 per year, so if you want to contribute more than that, you might consider adding your spouse to payroll.
There may be some other benefits to adding a spouse to payroll. For example, if your spouse is an employee (or owner) of the business, you may be able to deduct his or her travel expenses on business trips. You may be able to deduct his or her cell phone and vehicle miles. If you want your spouse to build credits for future Social Security payments during retirement, that might be another reason to add him or her to payroll.
Weigh Your Options Carefully
Although every situation is different, I don’t think most people would benefit by adding a spouse to payroll. There are probably more efficient ways to increase retirement contributions (such as by using a Solo 401k, SEP IRA, or a Defined Benefit Plan). Most of the time, deducting travel expenses and cell phone expenses would not justify the extra payroll taxes you would have to pay. Since a spouse can claim spousal Social Security without working (which is half of your benefit), a spouse who is otherwise not employed would have to get paid quite a bit over a long period of time to build enough credits to earn more than what he or she would be entitled to through spousal benefits and, in my opinion, there are better investments than building up Social Security credits for the future.
At the end of the day, whether or not you should pay your spouse is a decision you should weigh carefully. Calculate the pros and cons of the decision to see what option makes the most financial sense. Then, you can rest assured that you have made the right choice.
This article is meant to provide general information and should not be construed to contain individual tax or legal advice. Feel free to contact me at 801-923-8350 or email@example.com with any questions or for more information.
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