My husband, James, and I love running a business together, and we have many clients who work with their spouses as well.
If you and your spouse both work for your business, you may be wondering if you need to give your spouse a Form 1099 this year. In today’s article, I’ll explain why that’s not just a yes or no question, and I’ll also be sharing an exciting tax tip at the end (yes, that’s a thing!), so make sure you don’t stop reading before then.
Is Your Spouse Your Employee?
First things first, the IRS expects you to figure out what type of business relationship you have with your spouse, so it’s time to define your #relationshipgoals. If you control most of the management decisions and business operations while directing your spouse as an employee, then you have an employer/employee relationship. In this case, you’ll either give your spouse a Form W-2 or a Form 1099 (more about this choice later).
However, if your spouse has just as much control in the management decisions and operations as you do, contributes capital to the business, and is an equal with you in terms of the services you both provide for the business, then you have a partnership. In this case, you will either file a joint return and elect to be treated as a qualified joint venture or you can file a Form 1065, U.S. Return of Partnership Income (more about this choice later).
Should I Give My Spouse a Form W-2 or a Form 1099?
I’ve written a definitive guide on the differences between being a contractor or regular employee to help explain those classifications that determine whether you should be issuing a Form W-2 or Form 1099. But for the purposes of this article, you need to know that if your spouse is an independent contractor for your business, then you’ll need to provide a Form 1099 if they received more than $600 from your business during the year. If your spouse is an employee, you’ll need to provide a Form W-2. It’s really up to you, your spouse, and your accountant to determine which employee classification works best for your business.
Keep in mind that an independent contractor, often referred to as a 1099 employee, is responsible for paying their own self-employment taxes. On the other hand, regular employees, often referred to as W-2 employees, need to pay income tax and FICA (Social Security and Medicare) on their income. Additionally, your business will also pay income tax and FICA withholdings for W-2 employees, but you do not need to pay FUTA (unemployment tax) for a W-2 employee who is your spouse. If you’ve waited until the end of the year to make these determinations, you and/or your spouse may have to pay some tax penalties.
Many clients opt to not make their spouses W-2 employees if they don’t have other employees working for the business since it does create more paperwork overall. I highly recommend speaking with a CPA about employee classification since this area can be so complicated and can greatly affect your taxes.
Should We Elect to Be Qualified as a Joint Venture?
If you meet the following IRS requirements, you can elect to be qualified as a joint venture for federal tax purposes:
- You and your spouse are married and file a joint return.
- There are no other business partners except you and your spouse.
- Both you and your spouse participate substantially and continually in the business.
- Both you and your spouse own the business.
- Both you and your spouse elect to be qualified as a joint venture.
- The business is NOT structured as a partnership, limited liability company (LLC), or corporation. (Note that this last requirement may not apply to you if you own an LLC in a community property state.)
Opting to be qualified as a joint venture requires less paperwork than filing as a partnership, so this is an option many clients choose. When filing as a joint venture, each spouse will only need to fill out a Schedule C and Schedule SE with income and tax amounts while filing their Form 1040 tax return. Additionally, joint ventures do not need an employer identification number (EIN).
In contrast, filing as a partnership requires you to complete a very involved Form 1065 along with a Schedule K-1 for each partner to detail income. Additionally, you might complete a few other schedules (tax forms) depending upon your answers on the Form 1065.
Another big benefit of choosing to file as a joint venture is that your spouse will still be accumulating credits towards Social Security benefits by paying self-employment income taxes. These credits are important in determining your Social Security benefits and whether or not you’ll have to pay any Medicare premiums later in life.
As with many things tax-related, there are some disadvantages to qualifying as a joint venture. One drawback is that you may end up paying more in taxes than if your business was set up another way. Additionally, your business isn’t a separate legal entity, which could leave you personally liable for any business debts or legal issues. If you have questions about this designation, it would definitely be smart to speak with a CPA.
What’s the Exciting Tax Tip You Promised?
Hold on to your seat. If your business is a sole proprietorship or if you have an LLC that you elect to treat as a corporation for federal tax purposes, then you can give compensation to your spouse in the form of a Section 105 plan and save yourself lots of money in taxes. A Section 105 plan is a medical reimbursement plan that your business can set up to compensate employees.
Setting up compensation to your spouse in this way saves you money because the reimbursements paid to the Section 105 plan become business write-offs on the Schedule C of your Form 1040. This lowers your federal income tax bill and your self-employment tax bill. You also don’t have to pay Social Security and Medicare taxes on the money you place in the Section 105 plan, so you save even more tax money.
Your spouse can then use the compensation in the Section 105 plan to pay for your family’s health insurance premiums, dental insurance premiums and expenses, vision care expenses, and any other out-of-pocket medical expenses. Those reimbursements are a tax-free fringe benefit, so you save even more tax money while paying for your whole family’s medical expenses.
If you opt to provide your spouse’s total compensation through a Section 105 plan, then you won’t need to provide your spouse with a Form W-2 or withhold or pay any federal payroll taxes. You will need to make sure that the amount your spouse is being compensated through the plan is a reasonable amount based upon the work completed. This tax strategy might also not be a viable option for you if you have more employees than just your spouse, and it’s very important to keep clear documentation.
Determining the compensation amount, plans, and agreements should be done with the help of a CPA, but if done right, you’ll be very happy with your tax savings.
Action Steps:
- Determine whether your spouse is an employee or a partner in your business.
- If your spouse is an employee, issue a Form W-2 or Form 1099 and make sure you know and follow the requirements for that employee classification throughout the year.
- If your spouse is a partner in your business, decide whether or not you should elect to qualify as a joint venture or if it would make sense for you to compensate your spouse through a Section 105 plan.
- If you have questions about how to treat your spouse when it comes to your business and taxes, contact an accountant you can trust.
