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Should Your Company Hire Your Spouse?

Your spouse may spend a considerable amount of time helping out at the office. Sooner or later, you will probably ask yourself this question: Are there any tax advantages to making my spouse a formal employee? The answer depends on your individual circumstances.

Here are a few of the most important areas to consider when deciding whether or not to put your spouse on the payroll.

Income shifting: Assuming your company is a C Corporation, any compensation paid to your spouse would normally be left in the corporation. In other words, if your corporation is in a higher tax bracket than you and your spouse, you may save tax overall by paying your spouse a salary. Otherwise, there is no benefit (and possibly a detriment).

On the other hand, if you operate your business as an S Corporation or a sole proprietorship, you do not have to worry about corporate taxes. The income from your business is reported on your personal return, whether or not your spouse is paid a salary. Result: In this case, there is no income tax advantage to putting your spouse on the payroll.

Retirement plan: If your business has a qualified retirement plan in place, it may provide retirement benefits to your spouse as an employee. For example, if you have a 401(k) plan, your spouse can contribute a portion of his or her salary to the plan on a tax-deferred basis. Or the business may make contributions on behalf of your spouse to a pension or profit-sharing plan.

Fringe benefits: A C Corporation can provide certain tax-favored fringe benefits to its employees, including your spouse if he or she is a formal employee. For instance, your corporation may give each employee $50,000 of group-term life insurance coverage, which is tax deductible by the corporation and tax-free to the employee. Your spouse is entitled to $50,000 of tax-free coverage, separate and apart from yours.

Note: This tax break is not available if you operate your business as an S Corporation. SCorporations cannot deduct the cost of fringe benefits provided to employees who own more than a 2% interest in the corporation. For this purpose, an interest owned by one spouse is treated as being owned by the other.

Travel expenses: Under current law, you may deduct your spouse's travel expenses only if he or she is also a formal employee of the business. By putting your spouse on the payroll, you may be able to claim extra travel deductions if your spouse accompanies you on a business trip.

Payroll taxes: This is probably the major drawback to making your spouse an employee. Your business must pay employment taxes on your spouse's wages. And it must withhold FICA (Federal Insurance Contributions Act)—including Social Security tax and Medicare tax from the wages.

For example, if your spouse is an employee in 2006, your company and your spouse must each pay a 1.45% Medicare tax on all of your spouse's wages and a 6.2% Social Security tax on the first $94,200 of wages (up from $90,000 in 2005).

In conclusion: There are other factors besides taxes that can affect whether or not you pay your spouse a salary. Be sure to look at the “big picture” as well as the tax picture.

 

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