Hiring Your Spouse and/or Children
If you are in business for yourself (such as a partnership, sole proprietor, LLC, or a subchapter “S” corporation), and file a Schedule C, you should seriously consider hiring your spouse and/or children to maximize your bona fide business deductions. There are many tax savings reasons to consider this, assuming that your spouse and children can do bona fide work for you and are paid prevailing wages.
For example, what if you don’t have health insurance coverage paid by an employer? If you are self-employed, the usual route is to take the deduction for self-employed health insurance premiums on your 1040 form. This is better than it used to be (for many years they only allowed half of the premiums and before that didn’t allow any deduction), but it can be even better.
Besides health care insurance, (as well as dental, optical, and disability), as an employer you may offer additional benefits, such as long-term care insurance subsidy, bus pass, parking, training/continuing education (must be appropriate for employment), etc.
Schedule C Deductions are Always Better than 1040 Deductions:
It is almost always better to take as many deductions on your Schedule C, as Schedule C deductions reduce your income for self-employment taxes – usually 15.3% in most years (but is only 13.3% in 2011 and 2012). If you are covering a family of four, the premiums can vary depending upon your ages, deductible, co-pays, maximum out-of-pocket, etc. But say you paid $16,000 for health insurance last year. If you are in the 25% tax bracket, that means you will “save” $4,000 in income taxes.
However, if you don’t have any other employees, but you hire your spouse, and provide your employee with a benefit package that includes paying for dependent health insurance coverage, you now will save an additional $2448 in self-employment taxes!
Health Reimbursement Accounts:
But wait, there’s still more. Typically, many employers set up Flexible Savings Accounts whereby employees agree the year before to pre-tax deductions of what you estimate will be your out-of-pocket medical costs (i.e., deductibles, co-pays, co-insurance, plus for medical items such as band-aids, glasses, contact lenses, etc.). Trouble is, you won’t know in advance how much you will spend, and you could underpay, meaning you’d lose pre-tax deductions, or you’d overpay and risk losing that money.
A self-employed person can set up a Health Reimbursement Account (HRA) through a 3rd party vendor, such as BASEonline.com, and depending upon how many hours/week, and the rate of pay, you can enjoy far greater benefits, and not have to pre-pay, because, as the title implies, your employee’s expenses are reimbursable. And as you are giving your spouse employee benefits that cover their dependents, this also covers you and your children. Remember, this benefit is only available to employees, so if you are self-employed as a sole proprietor, this won’t work for you, only to your employees.
We’re not done yet in terms of spousal employment benefits. Besides health care insurance, (as well as dental, optical, and disability), as an employer you may offer additional benefits, such as long-term care insurance subsidy, bus pass, parking, training/continuing education (must be appropriate for employment), etc. [Check the IRS Publication 15-B, which lists fringe benefits such as dependent care, educational assistance, employee discounts, group-term life insurance, etc.]
Again, several of these may be deductible to the employee, but since the employer saves the additional Self-Employment tax rate, as a couple you’ll save more with the employer taking these deductions.
Hire Your Children:
OK, now let’s discuss the benefits of hiring your children. To comply, your children must do legitimate work, and be paid prevailing wages. There is no minimum age, but their job responsibilities must align with their capabilities. For example, children can do copying, mailing, filing, cleaning, organizing, billing and bookkeeping, website management, and so on. Here is a way for them to earn their allowance, get some spending money, save for college – and you get to take it as a deduction!
Additional benefit – there are no payroll taxes until your child turns 18 – again saving you money, them as well, and keeping more money in the family. All wages are deductible, so the employer gets to save the Self-Employment taxes. Should your child earn enough to be taxed, they will be taxed at a lower tax bracket than you will be.
Plus you can take their earnings and set up a Roth IRA. As they are probably not going to be paying taxes, it pays to put up to $5000/year into a Roth. It grows tax free and when they are ready to retire they’ll have a sizable sum of money that they can take out tax free!
If you have any questions, please feel free to contact me. You can reach me at firstname.lastname@example.org, you can visit my website at www.tangiblesolution.net, or call me at 206-890-1174. Take care and be well.