Should you hire your spouse?

About 10% of U.S. businesses are jointly owned by married couples, but that isn't the only way to work with your partner. For many small businesses, simply hiring a spouse can seem more beneficial than pursuing a partnership structure. But it isn’t a decision to be made lightly.

Not only is it helpful to consider operational and tax implications, but also review your financial plan to ensure that this structure will help you meet your goals.

In this article, we take a look at some of the benefits of hiring your partner, the risks, and best practices.

Why hire a spouse? The benefits are tempting

At first glance, hiring your spouse appears to solve a number of problems—especially related to expenses. Both spouses leverage deductible expenses from the business, either at the owner and a W-2 or W-9 employee.

For example, covering your spouse under employee health insurance may be more affordable than other options. Premiums can be written off as an expense —just as retirement contributions through the company. Business travel, too, can be considered a legitimate business expense, as well as life insurance, FICA taxes, business-related education expenses, and similar costs.

That said, this isn’t necessarily the best way to include your partner in the business. Not only are there more beneficial systems, but hiring your spouse as an employee can be a red flag on an IRS audit.

The problem: Higher scrutiny from the IRS

The IRS tends to look closer at family-based employment. The combined tax-savings and potential higher Social Security payout causes the IRS to want to confirm that your spouse is actually doing the work—not simply reaping the benefits.

Even skirting around some of the benefits—such as hiring your partner on a W-9—can generate questions and lead to IRS audits.

There are, of course, additional considerations. The cost of onboarding your spouse, for example, you will need to pay both Social Security and Medicare taxes for both you and your spouse. Then there is payroll costs.

Hiring your spouse as a W-9 can offset some of these expenses, but it severely curtails the benefits—such as healthcare and retirement tax deductions.

But the bottom line is that this model increases your risk of an IRS audit.

Best practices for hiring your spouse

If you do decide that hiring your spouse is best for your business and financial situation, here are some best practices to keep in mind:

Keep a papertrail. Ensure that your spouse’s W-2 or W-9 are in order, as well as health care coverage and retirement accounts. For your spouse to be an employee, they cannot also be a partner in the business. Partnership has its own tax structure and implications.
Put your spouse on payroll. Another way to highlight the authenticity of this setup is that your spouse is paid a regular salary.
Separate medical reimbursements from their salary. Having separate accounts for your spouse in regards to medical reimbursements and income can further highlight that they are an employee. Some strategies go so far as to suggest that your spouse enrolls the entire family (you included) in their health insurance policy under a self-insured Section 105 plan. However, this is only relevant if you have multiple employees.
Be aware of what tax-free benefits you can extend to your spouse. State and city regulations aside, some tax-free perks will not be available. For example, the Education plan under Section 127 prevents you from providing some benefits to your spouse. The same is true for deducting tax-free transportation perks, under the Tax Cuts and Jobs Act.

In some cases, it’s also possible to create a partnership rather than bring on your spouse as an employee. While the tax structure is different, partnerships are traditionally audited less than individual returns. It can also save you from payroll costs, and open up the potential for pass-through deductions for both yourself and your partner.