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
Now you know why no one is going to want to sell me life insurance. Name the peak for bonus points.
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.
Lawsuit Protection
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!
Great post. If spouses each have their own unrelated businesses, I’m guessing you can add each other to their respective businesses…but are contribution limits (i.e. solo 401k or SEP IRA) per individual, or per job/company? Thanks!
If you own both companies (or are married to the owner), your total contribution cannot exceed $53k. If your “day job” is an unrelated employer, then you can contribute up to $53k to each plan.
Both. https://www.whitecoatinvestor.com/multiple-401k-rules/ Two unrelated businesses could potentially have two 401(k)s.
Hi WCI;
Great post – I am a physician and hospital-employed. I max out my 401k every year (as well as HSA, backdoor Roth…etc..etc). My wife just started as a CRNA (here in Utah) and started a single-member LLC taxed as sole proprietor. She works about 3-4 days per week so my guess is that her total income will be about $100k-$120k this year. Plan is to maximize her individual 401k with $18k employee contribution and max employer profit-sharing (probably $30k-$35k total).
My question – is it possible to add me to her business as a manager and then be able to contribute to an individual 401k for myself. I wouldn’t be able to do another $18k employee contribution since I max out my 401k at work….or would I?
Your post was eye-opening in this regard.
Much appreciated,
-Brian
I would like to know the answer to this as well. I am in a similar position as an employee and my wife as an employee (both maxing out our regular 401ks $18k plus respective employer contribution)…
I’m creating a side Independent contractor business and would like a website for my wife to help run. She could become part of the LLC I plan to form and we both get to contribute to a solo401k employer contribution.
An example with rough numbers: I make $50k side income from LLC.
We each get 20% ($10k) we can contribute to a solo401k? Then we each have to pay taxes on the remaining $30k.
Please let us know if it’s legit. Thanks for your help!
Yes, that’s legit, except it’s $10K total, not $10K each.
She could add you as an employee and you could get up to $53k (in addition to your hospital job) into that SOLO-k. Keep in mind that your salary rate would need to qualify as “ordinary and necessary” as her business mgr.
Thanks much. That makes sense….. “ordinary and necessary” is something I recall reading before…that is probably why I made her a single-member LLC.
Yes, you could do that and put 20% of your net income (from the business) into it as an employer contribution.
Great post. I’d add that tax deferred investments are essentially levered at your marginal tax rate at withdrawal at 0 % interest. Tax deferral can be a financial bonus even if you put all your retirement money into Microsoft in the 70s and have a higher rate at withdrawal then when you were working.
RIP, WCI
?
Per your section “a succession plan”, I thought you were already dead.
Clearly not funny since I had to explain it.
Maybe I am. My knee kind of feels that way after a fall I took today while skiing.
>>(Who knows, maybe I’m already dead as you read this.)<< I got it 🙂
The headline sounded like an April Fool’s gag, but the article turned out to be a good read and in-depth look at the inner workings of a small business, something many physicians can relate to. Thanks for the insight!
In Utah, a charging order is not the exclusive remedy for a creditor of an LLC member – such a creditor can also foreclose on your membership interest if they can show that the charging order alone will not result in their timely payment.
Out of curiosity, did you consider putting WCI in a trust to remove it from your taxable estate before it became more valuable? Utah supposedly has a robust domestic asset protection statute. Is their an estate planning Utah attorney you have worked with, or recommend?
IANAL (sounds dirty, but just short for I am not a lawyer, so take anything I say with healthy skepticism).
Good thinking. No, I didn’t consider it. I’ll have to talk to an estate and/or an asset protection attorney about that.
Correct me if I’m wrong, but an LLC gets to choose when it disburses payments to its owners/members, but you gotta pay the tax man every year (or four times a year) regardless of whether you take that cash home. Seems a way for a creditor to get hit with a potentially big tax big every year without much to show for it.
Yes, that’s an asset protection technique some use.
If your wife formed her own LLC and you paid her under her LLC to provide the services mentioned above, would this change anything compared to the strategy you’ve taken?
Not really .She’d still have to pay payroll taxes and the 401(k) limit would still be the same. But then we’d have to pay and manage another LLC.
This was a good information but most of it would apply just as well if you hired your spouse. You wouldn’t have to file a partnership return, but you would have to file payroll tax returns. Depending on business profits, it might make more sense to not allocate 1/2 of the profits to your spouse through ownership, rather, pay her under full SS wage base (say $50k or $60k) and save 12.4% on the rest of the SS base (as it would go to you). Yes, her SS bene’s would eventually be lower, but you would almost certainly come out ahead as a couple by investing the savings.
Naturally, a different title wouldn’t have been nearly as shocking.
Yes, titles are clickbait. Welcome to the world of blogging.
The whole discussion at the end was about how much to pay her, balancing extra payroll taxes vs additional retirement account contributions. Perhaps we made the wrong decision; only time will tell.
I have been a long time reader of your blog and liked the financial breakdown that you provided as to the financial incentives of bringing your spouse into the LLC. I did cringe a little bit at a few of the comments regarding your views on your wife’s contribuions to wci.
“Allowing her to work for pay” Really?
“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.”
I would argue that having the free time and quiet space to be able to do all of the things mentioned above without having to concurrently tend to young children and keep up the day to day of the house has been a substantial contribution to the success of your business.
Your might want to give her some flowers!
Thanks again for the interesting financial breakdown.
There are a dozen roses on the counter as I write. As I wrote just last week on this blog:
She spent the day hiking. I spent the day backcountry skiing with two partners from work. We’re hosting a med student and his wife for dinner tonight as part of a program the alumni association runs. We have a great life.
You’re right that “allowing her” sounds funny like she’s some kind of dungeon prisoner. I’ll change the phrasing.
Docpmg, I think you just like to cringe.
WCI, good article, practical advice that many in the know have been using it for some time. Beats trying to have your spouse qualify as real estate professional
The SS evaluation needs to take into account that she will be entitled to half your primary insurance amount (PIA) when she reaches full retirement age whether she works or not. With not even 10 years of earnings history yet, she has to go a ways to clear that hurdle. Will WCI last that long?
It happens that my wife’s PIA on her own record is within a few percent of half of mine. 34 years of paying SS taxes will get her about zero extra retirement benefits. (There is some potential for value as disability or survivor benefits from her record.)
You’re right and we took that into consideration.
WCI, I am sure you did the math right about the benefits and costs of getting your wife a better SS benefit. But as a CPA who has done these calculations for dozens (hundreds?) of clients, it’s unusual in my experience to make paying SS taxes an attractive option.
People can’t really do this, but if a person could simply “opt out” of social security and invest the $11K to $12K cost themselves, I think you calculate an unadjusted-for-inflation future value of just under $1M in a situation like the one we’re talking about here. That’s usually a pretty big opportunity cost to pay for getting SS benefits and tax deferral benefit of a pension.
BTW, minor point of clarification: In community property states, husband and wife LLCs may choose to be treated for accounting purposes as a disregarded entity. That means in community property states, they don’t need to file partnership tax returns. Probably someone has already said this and I have missed it… but just in case I’ll mention here.
Stephen – that’s a good point about disregarded entities in CP states and I don’t believe it has been mentioned anywhere (certainly not by me). If you live in a CP state, you already know you do, but in case anyone reading this wants to know which states are CP, they are: AZ, CA, ID, LA, NV, NM, TX, WA, and WI. AL is an “opt-in” CP state.
BTW, when I wrote above “unadjusted-for-inflation future value of just under $1M” I really meant “adjusted-for-inflation future value of just under $1M”…
I.e., I used a real, after-tax rate of return to future value the $11K to $12K a year someone would pay in SS taxes (after adjusting for the income tax savings for the employer’s half of the SS).
Yes, but you need to compare that value to the real future value of the additional retirement account benefits. It’s a complex equation and I’m not sure it can even really be done in an accurate manner without a crystal ball.
I agree that paying SS taxes just for the Social Security benefits is not attractive. We had to look at the whole package, and even then it’s possible we still chose the wrong option. The whole package includes:
1) A lower overall tax bill for 2015
2) Another $53K pre-tax inside a tax-protected and in my state, an asset protected account. That money now has 4+ decades to compound in a tax protected manner.
3) Possible additional Social Security benefits
I’d love to discuss this point more because if I’m convinced what I did was wrong for us, we won’t do it again next year! We’ll just pay her something like $30K instead of half the site’s income.
Unfortunately, Utah is an “equitable distribution” state, not a community property state. That would be great to skip that 5 page return, simple as mine is. But everything I’ve read says I have to do the return.
I didn’t mean to say that what you did was suboptimal. Rather, I wanted to point out that your result is, from my experience, unusual.
And a couple-three other comments. First, I would TOTALLY agree with you that storing wealth inside a protected account makes particular sense for people with professional liability.
Second, I think the really tricky part of the tax deferral benefit math *is* calculating the difference between the marginal rate you guys are paying today (highest as you’ve shared) and the marginal rate you guys will pay in retirement (probably lower but maybe not). But If there’s not much spread, it gets harder and harder to justify the payroll tax hit you take.
BTW in the spirit of non-snarky-ness, I will tell you that I’ve often generously paid my wife for the work she does in my CPA firm even though the payroll tax hit more than eats up the tax deferral benefit on her pension. I don’t have an economically rational argument for doing this… except, well, it sort of feels right.
The reason you see my experience is unusual is perhaps I’m just wrong! But your “second” point is exactly what we were trying to decide between. If the spread isn’t large, it wasn’t worth the extra payroll tax except for the tax protected growth, asset protection, and extra SS benefits.
OK, I did the math in a blog post for a scenario like the one I’m guessing you, WCI, might personally face. Here’s the link:
http://evergreensmallbusiness.com/paying-payroll-taxes-to-bump-pension-contributions/
The scenario presented is probably optimistic but it illustrates the challenge of overcoming the “load” that the FICA taxes present… and it suggests putting a spouse on the payroll might actually drop your annual after-tax income in retirement by maybe $20K
A handful of hopefully helpful comments:
1. In my modeling, if you retire early (really early) and so don’t end up with gigantic balances in your accounts, that makes the proposition nearly breakeven using my approach. E.g., retire at 50 and you don’t save by doubling, but you nearly break-even.
2. A 401(k) plan doesn’t actually move the needle much as compared to a SEP (the vehicle I modeled for simplicity).
3. I didn’t do the math for the incremental improvement in your spouse’s SS benefits, but I’m guessing that value is (after tax) something like $2K to $3K… If it’s really $15K that makes adding a spouse to the payroll and pension a breakeven situation too.
So many variables. Surprised the 401(k) vs SEP didn’t make a larger difference, but I guess it’s only something like $2500 a year in extra medicare tax.
One can truly fall down the rabbit hole on this topic.
Thanks for the reply. She sounds like an incredible partner. I’ve felt for a long time that who you choose to marry is the single most important decision (including financial) that we make. I too, feel like I’ve won the lotto in this regard.
Both my wife and I are full time physicians getting paid w2. I also do 1099 consulting on the side with a LLC setup as sole proprietor. Besides getting another solo 401k for the wife, what else would be the financial benefits of adding her to the LLC?
Assume she also wants to do consulting – would it make sense to have her setup alone as a sole proprietor or join me
That’s the main one, but see the post for other possible ones for you.
Either is fine and would have similar benefits.
You would have the same benefits by hiring your spouse as you would if she were your partner or started her own business. ne big difference is that by hiring your wife, you will be able to control how much of her pay is taxed for FICA. If you both already max out, this is a non-issue.
Second, you will have payroll tax reporting by having her on the payroll. OTOH, as a partner, you will have to file a 1065, partnership tax return.
If you and your wife are truly in business together, i.e. you are both contributing to profits, a partnership or 2 separate sole proprietorships (filing 2 schedule C’s) would make more sense than hiring her. If your wife is simply “managing” your business, then it would be logical to hire her. In WCI’s case, his wife is an integral part of running the business and the partnership made sense.
Great article.. always learn something new! Im a full time W2 with a side consulting LLC. My wife works as a part time peds one day a week and as such is not offered 401k. So I employ my wife to take care of all of my travel arrangements.. I fly out weekly. I pay her about $1800 a month.. so about $21k annually enough to max her $18k contribution. Since its only a consulting business.. I don’t see any value in making her a member of the LLC or “employer” status? Some argue for the employer contribution to a 401k.. but essentially we would be splitting 50/50 the employer contribution between her and my name.. as oppose to 100% of the profit going into my name? And if the worse case scenario.. we part ways.. like the WCI said.. she would essentially get 50% of everything anyway!
I also employ my 2 kids.. one hour a day.. weekdays only at rate of $10/hr. One kid at a time and they take care of the banking (cash my checks on my cell), accounting (log in income and expense on spreadsheet), and office work (trash/tear up papers, clear up). They all have signed contracts and bank accounts. So they each get about $1200 annually which isn’t much in tax savings for now.. but I think reasonable for their ages.. 8, 9. I haven’t started a ROTH for them yet.. but its coming. I’d say the cumbersome thing is remembering to file quarterly payroll taxes for my wife.
Nice.
What kind of contracts do you have for the wife and kids? Did you have a lawyer look them over?
With this setup, do you pay a payroll service to hold the appropriate taxes, etc?
Side note: you fly out weekly?! If you don’t mind sharing, what do you do? Pm me if anything. Assuming United Airline global status?
Simple contracts… what are their expected responsibilities, hours and salary or pay rate. I did not have a lawyer look at but did this through the advice of a CPA.. in case of an audit. Not sure if this really helps? I do a lot of pharma speaking for drugs I use commonly in practice.
As long as you are not incorporated, you can hire your children under age 18 without having to pay FICA taxes. They will not owe federal/state taxes for any income up to the annual tax exemption amount.
If there were enough income in your side gig, like there is with WCI, to max out two individual 401(k)s, you might think differently about employing her versus adding her as a member. Plus you wouldn’t have to do the payroll taxes, just your usual quarterly estimateds.
Just curious why you haven’t been contributing to Roth IRAs for them yet?
Hard to get around the doubled self-employment taxes. 15%+ on spouse’s income is a big hit. Probably the most value is to get the spouse to 10 quarters or the first bend point for Social Security.
Yes, that’s the big issue if your spouse doesn’t have any other income.
WCI, you’ve had some great posts before about budgeting for an about to be first year attending. I am currently attempting to do that, and in the process understand the new taxes to be subjected to. This post mentions the federal income tax, state income tax, SSN tax, medicare, and obamacare that all add up to over 40% of one’s income. However some of those previous posts had allocated something like 20-33% (depending on the state) taxes on an attendings salary. Confused…
I’ll put in my .02. Your first year as attending is probably only a partial year at attending pay so your tax bracket will be lower than then next. The 20% bracket is probably applicable to resident pay unless your spouse works. FICA tax is 7.65 regardless (until you max out). Your effective tax rate will change a bit every year but will change the most when you move from residency to attending. The state you live in can move you up another 10% or so (even more if you live in NYC).
Marginal vs effective rate. My marginal rate is something like 46%. My effective rate is something like 25%.
Nothing beats brevity.
This is quite an interesting idea and I am toying with the idea of employing my wife.
Can anyone comment (or perhaps this is a great blog post idea) as to what the steps are to employ one’s spouse. My limited internet research is telling me:
1. Have a job description
2. Sign an employment contract?
3. Fill out an I-9 Form (and keep with your files)
4. Fill out a W4 (And keep with your files)
5. Fill out a State Specific (for example NY) W4
6. ? Report to the state that you are hiring someone?
7. Get access to a retirement account (in my case an individual 401K)
8. ? Pay Quarterly estimated payroll taxes and income taxes (federal and State if applicable)?
9. … got to this point.
My questions are really:
1. Does one have to report a new hire even if they are your spouse that you are hiring into your sole proprietorship business as an administrative assistant?
2. If I pay a significant amount of taxes via W2 income withholding that essentially covers my 1099 income and FICA taxes and also covers the extra FICA and income taxes of my employee (spouse), do I still have to pay quarterly estimated FICA taxes for my new employee?
3. Any thing else I am missing from the list above?
Any guidance is appreciated… especially of the right kind!
I don’t know as I chose not to hire my wife. I gave her half my business instead: https://www.whitecoatinvestor.com/why-i-gave-my-business-away/
But I did employ my kids, which is quite a bit easier. I did 1, 2, 3, and 4, 5 is not required in my state, didn’t do six, 7 they use Roth IRAs as they are part-time they’re not eligible for the 401(k), 8 kids don’t owe payroll taxes and they don’t make enough to owe income taxes. I sent the IRS a W-2/3 for each of them.
Thank you for the response Jim… This is very helpful and I am going to keep researching before pulling the trigger on this one.
This is a very helpful blog. I’m new to many of the topics you describe in this post, but I’m confused about one point:
How does one have both an Individual 401k and have employees? Everything I’ve read is that you can’t pay payroll _and_ make contributions to an Individual / Solo 401k?
Or is the answer to make payments to a child as if they are an independent contractor? I’ve read that that can be a tax flag.
Many thanks for your help with this.
A plan can exclude employees under age 21 and can also require at least 1 year of service (defined as 1,000 hours worked in a year) before eligibility.
Children who are ICs have to pay payroll taxes. They don’t if they’re employees of a business entirely owned by their parents. Since they’re part-time, I don’t have to make 401(k) contributions for them. When it’s only you and your spouse, you can still use an individual 401(k).
Thanks for the info on this. This is an interesting exception that is especially intriguing!
MM, since your spouse would be your employee, you wouldn’t pay quarterly estimates on him/her. You would withhold taxes and file payroll tax reports – quarterly 941s + an annual 940 + whatever is required by your state and locality. If by NY you mean NYC, you’ll have to pay unemployment and local taxes.
Yes, you’ll have to fiile a new hire report and your other steps are correct. Be sure you are paying a reasonable amount for the work description and responsibilities.
Really recommend you work with your CPA on this one.
Thank you JFOXCPACFP. I am looking to see if this is worth it… Sounds like it might be easier to pay her as an independent contractor (on a 1099) and she can set up her own I401K. Looks like this way the tax hit/benefit is the same and its a whole lot less paperwork.
Unfortunately, independent contractor status is not correct given the fact pattern presented. If the tax hit is the same either way, there should be no problem, but unemployment taxes are a problem. She would also owe the UBT (Unincorporated Business Tax). Hard to tell which way would be better w/o running the numbers which you can do with tax software.
NY is notorious for hounding taxpayers for every last cent. Believe it or not, tate governments, in general, are always harder on taxpayers than federal.
Thanks again JFOXCPACFP. if i pursue this route, I will contact you/your firm for some advice on how to set this up. I looked up UBT and it was specific for NYC (we are in Western NY right now). The reason for the hesitation:
I may significantly decrease my Self-employed income next year (which may make it hard for me to justify an employee). We are also considering a move out of NY and dont want to start a bunch paperwork requirements that would have to be redone if the business (us) moves out of state.
The only real advantage of doing this would be this year as my SE income is high and I want to be able to get some more money put away in tax-advantaged accounts but it may not be worth the hassle.
I understand your hesitation and it’s still early in the year, so you’ve got months to decide.
Just realized that I overlooked your 2nd question (first post). Yes, you can withhold enough taxes via paycheck to negate the need for making quarterly estimates. In fact, the IRS treats withholding as if it is spread evenly throughout the year. We take advantage of that when s-corp owners are behind in making estimates. A “net zero” year-end bonus allows them to catch up and avoid penalties and interest. You can catch up either person’s underpayment through extra withholding, assuming you file a joint tax return.
Thanks JFOXCPACFP. This information is truly valuable… I am going to spend a little more time looking to see if this would be worth it (based on when we move out of NY) and if it appears that this is something we should pursue, I will get in touch for more personalized advice. I do agree that NY State is notorious for hounding tax payers.. We were once in NY, moved out for some training (3 years) and we came back to NY. Very promptly the tax department from NY State send me an audit notice as to why we did not pay taxes to them during the years that we didn’t live there! luckily a letter and a phone call (with our out of state rental agreement) put a stop to the audit!
Thanks again and enjoy your weekend!
Excellent article! My husband is part of my company but because he has another job plus rental income, adding anymore income to him would mean bringing him to a higher tax bracket.
But we have plans for him to take extended breaks for extended vacations which may mean less income and at that time I could give him a dividend from the company if it makes sense.
Also, I know in Canada my company can make investments tax free to another Corp and we plan to buy real estate that way too so hence he has his name in the company too.
Thanks for the tips on succession planning.
I’m not sure you understand how tax brackets work. Only the money above the threshold is taxed at the higher percentage. I’m not Canadian, but do you guys always pay taxes separately?
Another very informative and useful post! I’m switching to a new position which is all 1099. I am currently an LLC, and am to filing to be taxed as an S corp and bring in ~450k annually. My CPA is recommending to pay myself half w2, and half dividends, as well as to employ my wife with a w2 and give her an annual salary of ~22k as you stated above to max out her employee 401k contribution. I would greatly appreciate your thoughts on this type of set up vs making her a partner. Also, with my current solo 401k, will I still be able to contribute my usual 53k (18 +35) + my wife’s 18k employee and 20% of her net income to the same account?
I think that’s very reasonable. I think you can still use the solo 401(k) since your employee is your wife, but I’d double check that if I were you. Your CPA seems like an obvious source.
I’m a little confused with the contribution limits of the 401k’s you mentioned.
I thought the IRS limit on a 401k pre-tax/roth account was 18k. But you mention 53k. How is this possible?
In your post, you also seem to suggest that if your spouse already works, adding another 401k can be beneficial. But how since the contribution limit of all aggregated 401k accounts is still 18k per year?
There are two IRS limits. The first is employee deductible or Roth contribution per person- $18K. The second is the employer+ employee deductible contribution per unrelated employer- $53K. So the way you get to $53K is you put in $18K and your employer puts in $53K.
I think WCI meant that you put in $18k and the employer puts in $35k to total $53k.
To get your spouse to the $53k, she would have to earn enough in job #2 for employer to put in $53k as a 20% contribution. This is a helpful post: https://www.whitecoatinvestor.com/multiple-401k-rules/
Well, technically the employer can put in all $53K.
Just trying to clarify the basics. Not sure if Jon is ready to delve into the technicalities based upon his question – but you’re the boss!
Thanks for clarifying, I’ll read that article you pointed to.
Hi White Coat Investor I’m a big fan,
In this article, is the fact that she is your spouse relevant to the setup you describe? I have a domestic partner to whom I am not married in any official way. Could he and I do something similar or is there something special about it being a spouse? Thank you!
@Dúnadan – you don’t have to be married to add your partner to the plan, but you will no longer qualify for a SOLO-k and your plan will cost a lot more for compliance and filing. You also might not want to give half of your business away if you are not married.
No, I don’t think the marital status was mandatory for this set-up. But there is an important point of asset protection here. If we get divorced, she is getting half my stuff anyway. So giving her half of it isn’t a big deal. In your case, you would truly be giving half your business away.
Edit- Not sure if you’re talking about the individual 401(k), but the only partner you can add to an individual 401(k) is a spouse.
Great information here. One detail that hasn’t been mentioned is the business offering the solo 401(k) plan can’t have any employees besides yourself and a spouse.
As the business grows, it’s natural to think of hiring your kids or additional employees. Either of those would invalidate the solo 401K. It would be hard to justify independent contractor status for a related minor and I’m pretty sure the employee exemption is specifically limited to spouses. Another non-obvious way to get an unwanted employee is having an independent contractor reclassified as an employee by the IRS based on their activities.
It be interesting to hear from someone who’s experienced something like this firsthand.
Employees under age 21 can be excluded from a 401k plan, so hiring your children (or any other employees) under age 21 would not invalidate the plan. Also, employees that work less than a 1000 hours annually can be excluded. Both of these issues typically apply to hiring your children.
Thanks! I hadn’t heard of either of those two exemptions for the 401K plans. Very helpful.
Plus if your kids are independent contractors they’ll have to pay payroll taxes, but not if they’re your employees.
In some states, if you have more than 3 employees (including owners at an LLC), you must pay Workers Comp (including minors).
As far as I understand the situation, treating a dependent minor as an independent contractor is a red flag at IRS?
Look up your state here (unless you happen to be in KY!) http://bit.ly/2bjJMwr
As for the red flag issue, I have never heard of that one and have clients who have used 1099’s for their children many times in the past, no payroll taxes, no problems. Would like to hear if anyone else has experienced differently.