I gave my business, The White Coat Investor LLC, away last year. Actually, that's not entirely true; I only gave part of it away. I used to own 100% of this business and was the only member of the LLC. For various reasons, I decided that wasn't wise. No, I didn't hold an IPO, and no, you can't buy a share. You see, I gave part of the business to my wife by making her the second member of my LLC. It turns out there are a lot of advantages, and a few disadvantages, to doing so.
Advantages of Adding Your Spouse As A Member Of Your LLC
The advantages include business benefits, lifestyle benefits, tax benefits, retirement benefits, estate planning benefits, and asset protection benefits. We'll go through each of these one by one.
Getting Help With The Business
One of the best parts of adding another member is that you can get some help with the business. WCI can suck up a lot of time and energy. In order to really meet it's mission, I need an increasing amount of help each year. The business was originally bootstrapped, and I was the CEO, CFO, editor, ad salesman, marketer, author, photographer, IT guy etc etc etc. You get the picture. I did everything from the writing to the coding to the negotiating. As the revenue increased, so have the expenses. Frankly, I have more ideas for improvement than I have time. I have had to put some of them off for months or even years simply because I was too busy. The more chores I can off-load, the more of those ideas I can implement. Even better, many times others have talents and skills that I don't. My spouse is educated, hard-working, and has many talents I don't. Even better, paying her instead of someone else for help keeps the money in the family.
Working With Your Spouse
While some people go to work to get away from their spouse, I actually enjoy spending time with mine. Working together is a significant benefit to me as we grow closer. Even better, we now have a business where we can both work from home on our own schedule while still making plenty of money. The nice thing about adding her as a member of the LLC (i.e. an owner) rather than an employee is that there is far less required to justify her income. If she were an employee we'd have to hassle with a bunch of time cards and such. Yuck! This is also a great opportunity for her to do something different from her usual volunteer work, get back into the work force, and gain skills that may be useful to a future employer.
There are other benefits available to a business where the only owners are spouses. We can hire our minor kids and not have to pay payroll or unemployment taxes. We can also use the same individual 401(k) rather than forking out for a real 401(k).
Another Retirement Account
If two 401(k)s are great, why not have three? By bringing my spouse on, we get access to yet another tax-deferred retirement account with a $53K limit. Pretty cool huh? Given our 39.6% federal tax bracket and our 5% state tax bracket, every dollar that goes into a 401(k) reduces our current year tax burden by 45 cents. If able to max it out, that reduces our income tax bill by almost $24,000 per year.
Social Security Benefits
My wife does not yet have her 40 quarters required to earn her own Social Security Benefits. By working for pay, she will earn enough quarters to qualify. The more she works, the more her benefit will be.
A Succession Plan
WCI is now too valuable to just throw away. As I explained to my wife recently, even if its revenue were cut in half upon my death, it would still provide ongoing income similar to that provided by a $5 Million insurance policy invested in a typical portfolio. We have to have a succession plan. By getting my wife more involved in the business, she would be better prepared for a seamless transition in the event of my untimely death. In fact, my business manager tells me they're not even going to tell you I'm dead for a year. I mean, I've got 30-40 posts already written and ready to be published. (Who knows, maybe I'm already dead as you read this.) They'll continue to take guest posts. They'll probably bring on some guest columnists. Maybe when my daughter gets old enough and is both a spine surgeon and a financial planner (her current career goals) she'll run WCI. Things may run a little bit differently, but we don't plan to pack up and go home. (Well, except for the fact that we're already at home.) WCI is here to stay.
The LLC structure also helps. In Utah, an LLC doesn't dissolve just because a member dies. My share would go to my heir- that is, my wife. Making her a member now eases any estate planning difficulties.
A multi-member LLC generally has better asset protection than a single member LLC in that a creditor can only get a charging order and cannot force distributions from the LLC. Add your spouse as a member and, voila, you have a multi-member LLC. The money that is now in her 401(k) instead of a taxable account also receives protection from creditors (not to mention taxes) in most states. There is little downside from an asset protection standpoint. If she decides to leave me, she's going to get half of our assets anyway, including the value of this LLC, so might as well give it to her now!
Disadvantages of Adding Your Spouse As A Member Of Your LLC
It's not all peaches and cream, of course. There are some downsides to doing this.
Loss of Control
Any time you go from one owner to two, there is a loss of control in how the business is run. But who are we trying to kid? She already has a big say in what I eat, how I dress, how we spend our money, how we raise our kids, and everything else in my life. Having the formal right to give input on how the business is run seems pretty minor.
Expense To Add A Member
It costs a few dollars and a little bit of hassle to add another member to your LLC. In my state, it was $37 and 3 minutes on the computer. No big deal.
More Tax Hassle
I turns out that a multi-member LLC, even when all members are spouses, still have to file a partnership return. So I got to learn how to file form 1065 this year and generate two K-1s. That was a bit of a pain, but in some ways it eased my tax filing burden, since I no longer have to type all those 1099s I get into Turbotax.
Additional Payroll Taxes
This was the big kicker. You see, any money earned by my spouse, who currently has no earned income, is subject to the exact same tax brackets my earnings face- 39.6% Federal and 5% state on the income side, and 2.9% Medicare and 0.9% Obamacare on the payroll tax side. However, there's another tax that my WCI earnings were not subject to- the 12.4% Social Security Tax due on the first $118,500 of an individual's earned income. This is a tax that we do not currently pay for my state-at-home wife.
Deciding How Much To Pay
Thinking about doing something similar? Then the following discussion is for you. If you want to add your spouse to your LLC, and you want your spouse to actually get some earned income from it, then the spouse actually has to do something that earns income. If they just have ownership but don't do anything, their income isn't earned. That's nice in that you don't have to pay payroll taxes on their earnings, but it also means they don't have any earned income to contribute to a retirement plan and don't have any additional SS earnings.
In my case, there is plenty of work for my spouse to do, so it really comes down to how much we want to be her income instead of mine. I figure there is no reason for her to own more than half of the LLC nor earn more than half of its income. So that's the upper limit. It also seems silly to pay her less than about $22,000 if the point is to be able to have another retirement account. That's where the maximum bang (retirement contribution) for the buck (SS taxes) is found as essentially all of the money earned can be put into the retirement account. She gets to put in $18K as an employee contribution, and 20% of her net earnings (net of self-employment tax) as an employer contribution. $22,000* 12.4% = $2728 in SS tax. Part of that is deductible, so in reality it will cost us $2,112 in order to contribute $22,000 into a retirement account. That contribution would give us an immediate savings of $9812 off our current year tax bill, tax-protected growth, additional asset protection, larger SS payments for her, and perhaps even a future stretch IRA.
The only real risk there is that in retirement we won't be able to pull that money out at a marginal rate of less than 44.6% (our current marginal income tax rate) minus 2112/22000 (9.6%), or 35%. Given that the 28% bracket goes up to $231K in taxable income, and our state tax is only 5%, I think that's probably a very good gamble, especially given all the other benefits.
Likewise, if she's going to earn anywhere near $118,500, we might as well pay her enough to max out the solo 401(k) at $53K. In our case, that works out to be around $185,000 or so. What is the Social Security cost to get $53K into the 401(k)? It's $118,500*9.6%= $11,376. (Remember we get a deduction for some of the payroll taxes.) What do we get for that? We get a current year deduction of $23,638, plus the future tax, asset protection, Social Security, and estate planning benefits. But that's obviously a lot less bang for the buck than when she only made $22K. Not counting all the other benefits, we would have to withdraw that money in retirement at a marginal rate of less than 44.6% – (11376/53000) = 23.1%. Not impossible, especially when using tax-deferred accounts to fill the 0%, 10%, and 15% brackets, but definitely a much taller order, and that's assuming marginal tax rates don't go up dramatically. It is much harder to place a value on the tax-protected growth, estate planning benefits, asset protection benefits, and future Social Security benefits, so it is difficult to say if it is really worth paying all that SS tax just to max out another individual 401(k).
What about between $22,000 and $118,500? How does that look? Well, if you run the numbers, there is another earnings figure where the marginal tax rate in retirement is similar to what you would require if you just maxed out the 401(k). It's about $75,000. So there is little point in paying the spouse anything between $75,000 and $185,000. So the ideal pay is either between $22K and $75K (probably closer to $22K) or above $185K. If your goal is to get the most bang for your Social Security buck, go with a figure close to $22K. If you highly value the estate planning, tax, asset protection, and SS benefits, go with at least $185K in order to max out the individual 401(k).
We had a tough time making this decision, but decided in the end to go ahead and max this thing out by making my wife a 50% owner. What really made us lean that way was the “bird in the hand” factor of a lower tax bill now, the potential additional Social Security benefits, and the fact that if we end up with RMDs so large that they're taxed at 35%+, well, that's a very good problem to have and means we have plenty of retirement income at which point optimizing our tax situation is much less relevant.
Your Spouse's Other Job
What? Your spouse already has a job? Even better. If your spouse has already maxed out his or her Social Security contributions, this is a total no-brainer to add them on to your LLC. An additional individual 401(k) for no extra SS taxes? Duh. Even if they didn't earn $118,500, every dollar of earned income they have outside the LLC makes adding them as a member and maxing out another individual 401(k) even more attractive.
What do you think? Do you have an LLC where the only members are you and your spouse? What does your spouse do to earn the income? How did you decide how much the spouse should earn? Comment below!