7 Tax-Smart Reasons to Hire Your Spouse
Many businesses are having trouble recruiting and retaining qualified workers today. Nearly 90% of employers reported difficulty filling open positions, according to a recent survey conducted by the Society for Human Resource Management. The report entitled, "The COVID-19 Labor Shortage: Exploring the disconnect between businesses and unemployed Americans," also found that 73% of respondents have seen a decrease in applications for hard-to-fill positions, including hourly, entry-level and midlevel nonmanagerial positions. Only 6% expect labor shortages to diminish by year end.
The hardest hit sectors are manufacturing, hospitality, food service and health care. Labor concerns are expected to worsen in sectors — like retail and food service — that traditionally experience a spike in revenue during the holidays season.
If your small business is currently understaffed, you might want to consider hiring your spouse as an official employee, especially if he or she is already familiar with the job. In addition to filling an open position, this move can pay off through various tax-saving benefits. Here are seven ways hiring your spouse can chip in with tax savings.
1. Retirement Savings
If certain requirements are met, an employer can deduct contributions made to a qualified retirement plan on behalf of its employees, including your spouse. For instance, if your company has a 401(k) plan in place in 2021, your spouse can elect to defer up to $19,500 ($26,000 if age 50 or older) for the year, in addition to any matching contributions by the company. Typically, a company will match up to 3% of compensation that's deferred. (For 2022, the maximum contribution amounts are increasing to $20,500 ($27,000 if age 50 or older).
Contributions compound in the account on a tax-deferred basis until withdrawals are made. This is a good way for your spouse to save for retirement independently.
2. Business Travel Expenses
In the normal course of events, you can't deduct travel expenses attributable to a spouse when he or she accompanies you on a business trip. This is a nondeductible personal expense. But the tax outcome changes if your spouse is a bona fide employee of the company and travels with you for business reasons.
As a result, your company can write off your spouse's business-related travel expenses, such as airfare or other transportation, lodging and 50% of the cost of meals (100% for restaurant-provided meals in 2021 and 2022). Plus, the benefit is tax-free to your spouse. The same basic rules apply if your spouse goes on a business trip alone.
3. Health Insurance Premiums
If you're currently paying to cover your spouse under the company's health insurance plan, you may be able to shift more of the cost to the company if your spouse is an employee. The company can deduct all the health insurance premiums it pays on behalf of your spouse — just like it can for other employees. Similarly, you can deduct 100% of the cost if you operate a self-employed business.
4. Additional Health Care Breaks
You might take the tax breaks for health insurance a step further with a Health Reimbursement Arrangement (HRA) if you operate a C corporation or you're self-employed. If certain requirements are met, the company may reimburse your spouse for out-of-pocket medical expenses and health insurance premiums, while the costs are deductible by the company. This is a win-win situation.
Likewise, if your spouse is covered by a qualified high-deductible health plan, he or she can contribute pretax income to an employer-sponsored Health Savings Account (HSA) or make deductible contributions above the line to the HSA. Your business can also contribute to your spouse's HSA. For 2021, the contribution limits are $3,600 for self-only coverage and $7,200 for family coverage. Your spouse may contribute an additional $1,000 if he or she is age 55 or older. As with an IRA, earnings in the HSA may accumulate without current tax. Withdrawals for qualified medical expenses are tax-free, and unused balances can be carried over from year to year.
Alternatively, your spouse can redirect pretax income to an employer-sponsored Flexible Spending Account (FSA) up to an annual limit (not to exceed $2,750 for plan years beginning in 2021). In some cases, your business can also contribute to your spouse's FSA. The plan pays or reimburses qualified medical expenses without any tax. If your spouse has an HSA, an FSA is limited to funding certain permitted expenses. Unused amounts at the plan year's end are generally forfeited, although the plan may provide a 2½-month grace period or a carryover of $550 to next year.
When a spouse joins the team as a bona fide employee, he or she may want to sharpen business skills. This may be particularly true if your spouse has been out of the regular workforce for several years. Your company can send your spouse back to school part-time with an educational assistance plan (EAP).
Generally, qualified education expenses of up to $5,250 a year that are paid or reimbursed through the EAP are deductible by the company and tax-free to the employee-spouse. But the plan can't discriminate in favor of the company's higher-ups.
It's likely that you and your spouse currently drive your own cars. Although you may derive tax benefits for your vehicle's business use, your spouse's expenses are purely personal and nondeductible.
However, if your spouse is employed by your company, you may be entitled to business deductions under a complex set of rules, including limits on so-called "luxury car" write-offs. It may even pay to buy a third car.
7. Group-Term Life Insurance
An owner's spouse is entitled to the same group-term life insurance coverage as other company employees (typically, equal to three or four times the individual's salary). Under long-standing tax rules, the first $50,000 of employer-paid group-term life insurance coverage is tax-free to the employee. Plus, any additional coverage is taxable at relatively low rates. Thus, having your spouse work for the company provides more insurance protection for your family.
Important: S corporation owners generally can't deduct fringe benefits like group-term life insurance for any employee owning 2% or more of the company. This rule is extended to coverage for an employee-spouse. Other complicated rules apply to partners in a partnership and limited liability companies.
Right for Your Business?
Before you hire your spouse to work at your company, there are other tax repercussions to consider, including income and payroll taxes your spouse will have to pay on wages and the resulting increase in taxable income on a joint tax return. However, this usually works out to be a good deal overall for a couple where one spouse is the business owner. Meet with your professional tax advisor to discuss whether this strategy would be beneficial for your situation.
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