Hire Your Spouse - How to Claim Valuable Business Deductions

For small business owners, hiring a family member is one of the soundest tax strategies available. However, many small business owners do not fully grasp the regulations and advantages of doing so. Some spouses are heavily involved in the family business, and some work more behind the scenes. Both situations can result in substantial tax savings. Depending on the type of entity, ownership structure, revenue, age of owner and spouse, and number of outside employees, there are several ways to maximize savings.

Should your spouse be on the payroll?
If a spouse is working for the company (whether as an advisor or taking care of specific tasks), they would presumably have a salary. One way to save on taxes in this situation is to run payroll for the spouse and contribute to their 401k. The 401k contribution limit for 2021 remains unchanged at $19,500, plus an additional $6,500 if you are 50 or older. The business owner/employee and their spouse could each contribute up to $19,500 (or $26,000 if over 50).
Some situations where a business does not run payroll for spouse or family member can still have tax savings. For example, non-working spouses can create what is called a Spousal IRA. For a Spousal IRA, a working spouse must have eligible compensation that is at least as much as the total contribution to both IRAs and file a joint income tax return. Bottom line, you don’t need to cut a paycheck to fund an IRA or Roth IRA.
How should a 401K be managed?
While paying a salary results in taxes paid in the form of FICA, the ultimate benefit in deferred taxes is significant due to the time value of money. There is an opportunity for the spouse to create and fund a 401k. In a case where a spouse wants to draw a minimum salary only for tax deductible 401k savings, the payroll amount would “gross-up” to cover the FICA taxes and then “zero-out” the taxable income through the 401k contribution. For example, if a spouse is under age 50, the payroll amount would be approximately $21,000 with a net pay of $19,500. Then with the $19,500 deferral, the W-2 taxable wages reported on the tax return net out to close to zero.
The company can also match 401k (total contribution not to exceed 100% of compensation), which would be a deductible expense for the company and a pre-tax contribution to the retirement fund for the spouse. Profit share plans and SEP IRA contributions are more ways to contribute pre-tax money towards retirement funds.
What are some tax-free employee benefits?
Paying a spouse entirely with tax-free fringe benefits results in additional savings. The only conditions are that your spouse actually works for the company and that compensation is fair. It is important to note that S-Corp owners generally can’t deduct fringe benefits for any employee owning 2% or more of the company. This prohibition extends to coverage for an owner’s spouse.
Expenses for items that help your spouse do their job, like a smartphone or computer, can be deducted without keeping records of the item’s business use. Occasional low-cost meals, gifts, event tickets, or flowers can also be deductible by the business.
Job-related education for your spouse/employee can be deductible if it follows Section 127 education programs, and employers may provide their spouse up to $50,000 in group-term life insurance coverage tax-free.
Certain employee benefits, such as health insurance, are not taxable income for the spouse. However, they are deductible expenses for the company. Also important to note, if you pay a spouse with tax-free fringe benefits only, you need not pay payroll taxes, file employment tax returns, or file a W-2 for your spouse.
How can you create a medical reimbursement arrangement?
Healthcare benefits are usually the most considerable tax-free employee fringe benefit you can take advantage of. By hiring your spouse and adopting the right plan, your family’s health insurance premiums and medical costs are turned into deductible business expenses.
If your spouse is the sole employee of your company, the best possible way to pay for health expenses is to establish a spousal health reimbursement arrangement or 105-HRA. With a single employee, your 105-HRA is not subject to Affordable Care Act (ACA) restrictions, which ban standalone HRAs.
How can you create a medical reimbursement arrangement?
To max out your Social Security benefits, you would need to bring home approximately $142,800 a year from your business. If you push $142,800 for ten years, then you’re fully qualified or fully insured, and your non-working spouse is then eligible for 50% of the benefits.
What tax-free benefits should you approach with caution?
Transportation benefits need to be claimed carefully. Per the Tax Cuts and Jobs Act, transportation benefits to your employees are not deductible anymore. We recommend you keep a proper log of any mileage claimed.
As mentioned above, the law prohibits Section 127 education benefits to your spouse and dependents under the 5% ownership test, so that needs to be followed closely.

Be sure to consult with your tax professional to analyze your specific tax situation. At Taxperts, we can assess your small business structure and suggest ways to increase your savings. Check out our website, Facebook page, or LinkedIn page to learn more.

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