If you own your own business and operate as a proprietorship or partnership (wherein your spouse is not a partner), one of the smartest tax moves you can make is hiring your spouse to work as your employee.
But the tax savings may be a mirage if you don’t pay your spouse the right way. And the arrangement is subject to attack by the IRS if your spouse is not a bona fide employee.
Here are four things you should know before you hire your spouse that will maximize your savings and minimize the audit risk.
1. Pay 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, but not taxable income for your spouse.
Also, if you pay a spouse only with tax-free fringe benefits, you need not pay payroll taxes, file employment tax returns, or file a W-2 for your spouse.
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. 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. There are many other tax-free fringe benefits you can provide your spouse in addition to health insurance, including education related to your business, up to $50,000 of life insurance, and de minimis fringes such as gifts.
4. Treat your spouse as a bona fide employee. For your arrangement to withstand IRS scrutiny, you must be able to prove that your spouse is your bona fide employee. You’ll have no problem 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.