Should You Put Your Spouse on Payroll in a Family Business?

Many family businesses rely on a spouse’s contributions without formally including them on the payroll. In many situations, adding your spouse to payroll comes with tax benefits and other savings that can outweigh the administrative burden. However, when deciding whether to add a spouse to your payroll, their role in the business and the company’s choice of entity selection can affect the decision. Adding your spouse to the company payroll can carry certain tax risks and an added administrative burden. But in many situations, adding your spouse to the payroll comes with enough advantages to make any additional burden worth it.

Key Takeaways

• Business owners may benefit from putting a spouse on payroll. Sometimes they are formalizing a pre-existing role. Other times, adding a spouse to the payroll allows the spouse to qualify for Social Security benefits, Medicare, the business’s retirement plan, or other employment benefits.
• The business’s entity selection will affect the specific benefits of adding a spouse to the company payroll.
• Adding your spouse to the payroll can come with downsides, such as additional administrative burden, tax consequences, and potential IRS scrutiny. However, following the correct steps for adding a spouse to the company payroll will help ensure compliance with applicable tax laws.

Why Do Businesses Consider Putting a Spouse on the Payroll?

Business owners consider putting a spouse on their payroll for various reasons. Sometimes, they are simply formalizing a pre-existing role, such as a spouse who has been helping with scheduling, bookkeeping, marketing, or running the office. Other times, a business owner may consider adding their spouse to the payroll to build the spouse’s earnings record so they qualify for Social Security benefits or can contribute to the family’s retirement plan. In other situations, adding a spouse to the payroll allows the spouse to qualify for health insurance coverage or other benefits the business offers. Depending on your situation, adding your spouse to the company payroll can offer significant advantages.

Potential Tax Advantages of Putting Your Spouse on the Payroll

Adding your spouse to the payroll can provide significant tax benefits. A business owner can increase their household retirement savings by having their spouse contribute to a 401(k) or IRA. Issuing a W-2 allows a spouse to qualify for Social Security and Medicare benefits. Having your spouse on the payroll may allow you to write off the cost of their health insurance premium as a tax deduction. As an employee, a spouse gains access to dependent care and other employment benefits that would not be available to them as a non-employee.

Choice of Entity Can Impact the Advantages of Putting Your Spouse on the Payroll

The specific advantages available to a business owner who puts their spouse on payroll will depend on how the business is structured:

• For sole proprietorships and single-member LLCs, the spouse’s wages are subject to income tax and Medicare withholding, but are generally exempt from unemployment tax.
• For businesses operating as a partnership, the business may need to file taxes as a partnership using Form 1065 rather than adding a spouse as a W-2 employee.
• If the business is structured as an S-corporation, the spouse’s compensation must be “reasonable.”
• For C-corporations, the spouse should be treated as any other employee. The business can fully deduct the cost of employee benefits, and the employee can open their own retirement account.

The benefits and drawbacks of adding your spouse to the payroll can vary considerably depending on the business entity structure.

Downsides of Adding Your Spouse to the Payroll

Although there can be many advantages, there are also some drawbacks to consider when adding your spouse to payroll. For instance, you might face additional tax obligations, such as a higher employer match for Social Security and Medicare benefits. The additional earnings could increase your household Adjusted Gross Income (AGI), which could move you into a higher tax bracket with a higher tax rate.

Adding your spouse to the company payroll may also increase the administrative burden of payroll processing and filing an extra W-2. In addition, it can trigger additional scrutiny from the IRS, as auditors closely review family employment situations.

It’s also important to consider that your unemployment insurance and other payments associated with adding an employee may increase.

How to Avoid IRS Scrutiny When Adding a Spouse to the Payroll

The IRS takes a particularly close look at family employment situations to ensure they are legitimate. Protect your family and your business by carefully documenting your spouse’s job duties and wages earned, and ensure the wages are reasonable for the job performed.

Otherwise, treat your spouse as you would any other employee. Use standard payroll processing, and pay them on the same date and in the same way as you pay other employees. Ensure they meet the same benefit eligibility requirements as other employees and that all tax withholdings and filings are handled properly.

When Not to Add Your Spouse to the Payroll of a Family Business

Of course, there are situations when it does not make sense to add your spouse to the company payroll for a family business, such as if their involvement is minimal or sporadic, the administrative burden outweighs the potential tax advantages, or if business income is too low to justify the additional expense.

The Right Way to Add Your Spouse to Payroll

If you decide that adding your spouse to the payroll of a family business makes financial sense, ensuring that you handle the process correctly can avoid unwanted scrutiny from the IRS. Be sure to:

1. Create a job description that identifies your spouse’s job duties and responsibilities.
2. Pay a wage that is reasonable for their job duties and is consistent with what other employees in a similar role are paid.
3. Add them to your business’s payroll processing system, using their name, address, and Social Security Number.
4. Secure the appropriate workers’ compensation and unemployment insurance coverage.
5. Maintain appropriate employment documentation, such as time sheets and pay stubs.
6. Issue a W-2 and withhold the appropriate taxes.
7. Revisit their role annually as business needs continue to evolve.

In the right situation, adding a spouse to the business payroll can offer significant advantages. Avoid unwanted IRS scrutiny by handling it correctly.

Considering Adding Your Spouse to Payroll? Gudorf Tax Group Can Help.

The Ohio accounting and tax preparation professionals at Gudorf Tax Group can analyze your situation and help you decide whether adding your spouse to the payroll of a family business is right for you. We offer comprehensive tax strategies to help businesses navigate the complex tax landscape. Contact Gudorf Tax Group today to schedule an appointment.