This is a very important question and something we often analyze for clients in our office. In fact, many clients rush to put their spouse on payroll, but for the wrong reasons and it could actually be a costly mistake. However, there are 3 reasons why it could actually save you thousands to write them a paycheck before year-end.
First, is the goal to maximize the spouse’s 401k contribution. If your spouse doesn’t have a 401k or you are looking to find additional tax deductions, this could be a very wise and profitable move. In fact, if you can afford it and want to get even more creative you could fund a ROTH 401k and create a tax free account, rather than just deferring taxes until the future.
For example, this year (2015) your spouse could contribute up to $18,000 (or $23,000 if over 55) and your Company take a tax deduction for the W-2, while your spouse doesn’t claim any income on the W-2. Even though you pay some FICA or payroll tax on the W-2 amount in order to ‘fund’ the 401k, the ultimate tax benefit is significant due to the ‘time value of money’ and the opportunity of the spouse to create and fund a 401k.
Second, if your family has a lot of medical costs, putting your spouse on payroll may allow you to utilize the 125 deduction or Health Reimbursement Arrangement (HRA). However, keep in mind that you would have to utilize a Sole-Proprietorship (something I call a ‘family management company’) or a C-Corporation. This strategy is impossible in an S-Corporation for the owners unless they utilize this 2nd entity as I just described. However, if your family has more than 5k in out of pocket medical expenses (over and above health insurance premiums), implementing the plan can create savings far in excess of the costs to implement the plan.
I discuss this strategy more fully in my new book “The Tax and Legal Playbook” and compare the HRA to the Health Savings Account and other health care strategies. The beauty of the HRA (Health Reimbursement Arrangement) is your payroll need only be minimal and this is not a ‘use it or lose it plan’, but a reimbursement plan that can allow a couple/family to deduct almost all of their medical expenses at any age.
Third, and the final reason for putting a spouse on payroll is to make them eligible for their own Social Security benefits. On the face of it, this would seem logical, right? Paying into Social Security so that your spouse will at least get some benefit in the future when they turn 59 1/2. However, this is very misleading. For example, a “non-working spouse” of a “working spouse” already qualifies for spousal benefits. Now, although these benefits are limited to 50% of the working spouse’s primary insurance amount, it could actually be best to opt for just the 50% benefit. Speak with a financial advisor that understands Social Security planning to ‘run the numbers’ before rushing to cut another payroll check.
In summary, please consider this issue carefully and consult with your tax advisor before blindly choosing payroll levels or any payroll at all for your spouse.
Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions” and “What Your CPA Isn’t Telling You- Life Changing Tax Strategies”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com.