When it comes to saving on taxes, hiring your spouse as an employee in your business can be a game-changer, especially if you're a sole proprietor or have a single-member LLC. However, to unlock the full potential of this strategy, it's crucial to understand the ins and outs of employing your spouse. In this blog, we'll walk you through five vital tax-saving tips for employing your spouse and optimizing your tax situation.
1. Opt for Tax-Free Employee Benefits Over Taxable Wages
To maximize your tax savings, prioritize tax-free employee fringe benefits instead of cash wages for your spouse. Paying your spouse cash wages means both federal and state income taxes and Social Security and Medicare taxes will apply. Instead, focus on tax-free perks like health insurance, which is deductible for you as the employer and tax-free for your spouse. By doing so, you can significantly reduce your tax liability.
2. Leverage the Power of Medical Reimbursement Arrangements
Consider establishing a Medical Reimbursement Arrangement (105-HRA) to boost your tax savings further. This arrangement allows you to deduct health insurance premiums and medical expenses as business expenses, resulting in lower income taxes, as well as reduced Social Security and Medicare taxes. The 105-HRA is particularly advantageous for businesses with a sole employee (your spouse), as it bypasses Affordable Care Act (ACA) restrictions.
3. Unlock Additional Tax-Free Fringe Benefits
Expand your tax-saving strategy by exploring other tax-free fringe benefits for your spouse-employee. These may include tax-deductible job-related education expenses, tax-free group term life insurance coverage, working condition fringe benefits (such as providing business-related smartphones), and petty fringe benefits like occasional meals or small gifts. Leveraging these benefits can further enhance your tax savings.
4. Be Mindful of Certain Tax-Free Benefits
While tax-free benefits are valuable, be cautious with Section 127 education plans and transportation benefits. Section 127 benefits do not apply to spouses and dependents under the 5 percent ownership test. Transportation benefits may not provide a net benefit for you and your spouse due to recent tax law changes.
5. Ensure Your Spouse Qualifies as a Bona Fide Employee
To safeguard against potential IRS scrutiny, it's essential to establish your spouse as a bona fide employee. This involves ensuring that your spouse is not a co-owner of the business, performs genuine work, maintains accurate records of hours worked, receives regular payment from a separate account, works under your direction and control, and receives reasonable compensation, primarily in the form of tax-free benefits.
Employing your spouse in your business can be a powerful tax-saving strategy if executed correctly. By prioritizing tax-free employee benefits, setting up a Medical Reimbursement Arrangement, and exploring other tax-free fringe benefits, you can significantly reduce your tax burden. Remember to meet the criteria of a bona fide employee to fully maximize your tax savings. For personalized advice tailored to your unique situation, consult a tax professional and seize the opportunity to make the most of employing your spouse for tax relief.
You can reach our CEO and Owner Peter Ellefson anytime at Peter@eplfs.com Disclaimer: Laws and regulations are subject to change, and readers are advised to consult EPL advisors for personalized advice and compliance with specific state requirements. This information is not specific advice and is meant for general education.