One of the smartest tax moves you can make for your service business is hiring your spouse to work as your employee, but there are some pitfalls you must avoid if you don’t want all that tax savings to disappear.
You also don’t want the IRS breathing down your neck for setting the working relationship up incorrectly so here are four things you need to know before bringing your spouse on as your employee.
These will maximize your tax savings and minimize the audit risk, so it’s definitely worth your time to do this research and get this right beforehand.
1) Pay them benefits, not wages
The way to save on taxes is to pay your spouse with tax-free employee benefits, not taxable wages. Benefits such as health insurance are fully deductible by you as a business expense, the same can not be said for the taxable income for your spouse.
Also, if you pay a spouse only with tax-free fringe benefits, you don’t have to pay payroll taxes, file employment tax returns or a W-2 for your spouse so the whole documentation aspect of the business relationship is much less complicated.
2) Establish a medical reimbursement arrangement.
The most valuable fringe benefit you can provide your spouse-employee is reimbursement for health insurance and uninsured medical expenses.
It’s easy enough to establish. You can accomplish this through a 105-HRA plan if your spouse is your sole employee, or an Individual Coverage Health Reimbursement Account (ICHRA) if you have multiple employees.
3) Provide benefits in addition to health coverage
On top of health insurance, there are a number of fringe benefits you can provide to your spouse that are tax-free including education expenses related to your business, up to $50,000 in life insurance coverage, and even de minimis fringes such as gifts.
Sending your spouse to learn a new skill that you can apply to your service business is a great way to grow your business and a great use of your deductible expenses.
4) Treat your spouse as a bona fide employee
Your spouse can’t just pretend to be an employee “on paper”, they need to do actual work within your service business in order to stand up to IRS scrutiny. In order to prove your spouse is a bona fide employee, it’s fairly simple. You’ll have no issues if:
- you are the sole owner of your business,
- your spouse does real work under your direction and control and keeps a timesheet,
- you regularly pay your spouse’s medical and other reimbursable expenses from your separate business checking account, and
- your spouse’s compensation is reasonable for the work performed.
If you follow these four tips you won’t have any issues with the IRS regarding your spouse working for your service business, and you will be able to take advantage of some excellent tax savings and deductibles.
No guarantees on working with your significant other being a smooth ride though! That part is up to you.
