Spouse 401K through your practice

[blephptosisbrow]

Hello. My boss owns our small but successful practice. His wife comes by like 3 days a week for like 30 minutes to help drop off stuff for clinic and does odd jobs for the clinic sporadically. She also sits in on meetings with our advertisers. I recently found out that she is a staff member but takes zero salary but the clinic does give her a 401k which is fully funded. I don't have an issue with this as long as this is legal which it seems to be. I was wondering if this is indeed legal as I will likely be a partner this year given our most recent talks. It may be something to bring up as part of the practice purchase. Thank you.

[jacoavlu]

I recently found out

how?

if she’s an employee she can be a 401k participant

i presume the 401k has a competent TPA who is making sure that participant plan contributions are supported by their W2 compensation amount and that the plan is in compliance with applicable regulations

[spiritrider]

Since both employer matches and non-elective employer contributions are based on compensation, no compensation no employer contributions.

I'm with jacoavlu on this. How do you know this and what do you consider "fully funded". She is a participant and eligible for a full employer match and/or non-elective compensation based on her compensation and elections.

[jfoxcpacfp]

It could be that she is not taking a paycheck, which is different from no compensation. I will presume this is what you "found out" (no interest in the how). It is possible to take a net-zero paycheck in order to fully fund the 401k. It w/h/t/b grossed up for other taxes, of course, and any difference w/b w/h as fed/state taxes.

[blephptosisbrow]

The office manager told me that she (the owner's wife) technically works for our practice. She does not take a salary but her 401k is "fully funded". I assume that means $19,500 without a match because there is no salary to match. I am wondering if this is legal. I assume it is but just wanted to make sure as I didn't know if I would need to address this in the future. Honestly, I have no issue with the situation and may want my wife to do the same when I become owner if it is indeed legal.

[RDB]

My wife is an employee of our practice. She definitely has a role with decision making, marketing decisions, etc etc. My accountant runs the numbers and tells me exactly what to pay her in order to max the employee contribution to her 401k and get a $0 "check". I think this is fairly common. I am sure many spouses have this arrangement and do nothing for the practice. I do not think this situation is big deal, but it is something you will want to be aware of as far as how you each are compensated as partners. Until then, it is not really any of your business. My guess is this just reduces your bosses compensation, increases his spouses, and reduces their taxes.

[RDB]

The office manager told me that she (the owner's wife) technically works for our practice. She does not take a salary but her 401k is "fully funded". I assume that means $19,500 without a match because there is no salary to match. I am wondering if this is legal. I assume it is but just wanted to make sure as I didn't know if I would need to address this in the future. Honestly, I have no issue with the situation and may want my wife to do the same when I become owner if it is indeed legal.

There is a salary to match, it is probable a little over 20K in order to account for the 19.5 contribution and some taxes. So if you have a 3% match, she would likely get a 3% match on that number.

[jacoavlu]

The office manager told me that she (the owner's wife) technically works for our practice. She does not take a salary but her 401k is "fully funded". I assume that means $19,500 without a match because there is no salary to match. I am wondering if this is legal. I assume it is but just wanted to make sure as I didn't know if I would need to address this in the future. Honestly, I have no issue with the situation and may want my wife to do the same when I become owner if it is indeed legal.

perhaps you should be concerned with the behavior of your office manager.

[spiritrider]

The OP might have misunderstood or was misinformed. It is likely as RDB stated; she is receiving a $21,115.32 salary with $1,615.32 FICA taxes and $19,500 employee deferral resulting in a $0 net pay check.

In other words, it is $0 pay and not $0 salary. While this might be commonly done, it is almost prima facie evidence that the spouse's compensation is a not a fair market value (FMV) wage for business necessary tasks.

If I was an IRS examiner during an audit and I saw this, I would be all over this obviously sham compensation amount. It seldom makes sense to target the salary to be exactly what is necessary to maximize 401k contributions with the least FICA taxes.

Especially, when it is totally unnecessary to wave a red flag in front of the bull. For example, a salary of $400/week ($20,800/year) or $1,750/month (21,000/year) gets you pretty darn close to a $19,500 employee deferral and far more defensible.

[jacoavlu]

The OP might have misunderstood or was misinformed. It is likely as RDB stated; she is receiving a $21,115.32 salary with $1,615.32 FICA taxes and $19,500 employee deferral resulting in a $0 net pay check.

In other words, it is $0 pay and not $0 salary. While this might be commonly done, it is almost prima facie evidence that the spouse's compensation is a not a fair market value (FMV) wage for business necessary tasks.

If I was an IRS examiner during an audit and I saw this, I would be all over this obviously sham compensation amount. It seldom makes sense to target the salary to be exactly what is necessary to maximize 401k contributions with the least FICA taxes.

Especially, when it is totally unnecessary to wave a red flag in front of the bull. For example, a salary of $400/week ($20,800/year) or $1,750/month (21,000/year) gets you pretty darn close to a $19,500 employee deferral and far more defensible.

Hanlon's razor situation

all possibly true, but if I were an employee who otherwise liked the practice and wanted to buy in, I would probably keep my mouth shut about it before a deal.

I think it's more likely that the boss is just ignorant, as opposed to nefarious, about the specifics of spouse's pay how an IRS examiner would look at this. My guess is just as much blame to lay on the CPA giving poor advice.

[spiritrider]

My accountant runs the numbers and tells me exactly what to pay her in order to max the employee contribution to her 401k and get a $0 "check".

I just sighed when I saw this. Based on my last paragraph, an accountant should understand nuances.

Notwithstanding the minimum salary to max 401k employee deferrals and employer contributions is seldom reasonable compensation for a full-time S-Corp 2% shareholder-employee. At least for 2020 it is $150K and defensible in appearance ($12,500/month).

However, I wonder how many WCI forum members and other professionals paid themselves the minimum $148K for 2019 When the far more defensible $150K would have only cost an additional $58 in FICA taxes.

Perspective people, perspective.

Similarly if I was in this situation for 2021, I would pay myself ($13K/month = $156K/year) rather than the $154K minimum.

[RDB]

I just sighed when I saw this. Based on my last paragraph, an accountant should understand nuances.

Notwithstanding the minimum salary to max 401k employee deferrals and employer contributions is seldom reasonable compensation for a full-time S-Corp 2% shareholder-employee. At least for 2020 it is $150K and defensible in appearance ($12,500/month).

However, I wonder how many WCI forum members and other professionals paid themselves the minimum $148K for 2019 When the far more defensible $150K would have only cost an additional $58 in FICA taxes.

Perspective people, perspective.

Similarly if I was in this situation for 2021, I would pay myself ($13K/month = $156K/year) rather than the $154K minimum.

Good stuff!! Looks like I have some reevaluating to do. I think most of us just listen to our accountant, which is not always the best situation. I appreciate the insight!

[spiritrider]

I'm not saying there is any real likelihood of this coming up unless you were audited for another reason, but such an arbitrary amount to the penny based on contribution requirements and not business requirements would be hard to justify if challenged. This is a rather lazy CPA response to a client request without any real thought behind it. Then again maybe I am asking too much, but a good CPA should apply a smell test to client requests.

[blephptosisbrow]

Thank you all for the information. Yes, after talking to some friends it does seem rather common for practice owners to do. No, I will not be bringing this up in the negotiation for buy-in but yes I would like the same option for my wife if we are establishing equal ownership. Maybe we can pay them a small bit more so that number doesn't add to zero.

[litovskyassetmanagement]

The OP might have misunderstood or was misinformed. It is likely as RDB stated; she is receiving a $21,115.32 salary with $1,615.32 FICA taxes and $19,500 employee deferral resulting in a $0 net pay check.

In other words, it is $0 pay and not $0 salary. While this might be commonly done, it is almost prima facie evidence that the spouse's compensation is a not a fair market value (FMV) wage for business necessary tasks.

If I was an IRS examiner during an audit and I saw this, I would be all over this obviously sham compensation amount. It seldom makes sense to target the salary to be exactly what is necessary to maximize 401k contributions with the least FICA taxes.

Especially, when it is totally unnecessary to wave a red flag in front of the bull. For example, a salary of $400/week ($20,800/year) or $1,750/month (21,000/year) gets you pretty darn close to a $19,500 employee deferral and far more defensible.

The main idea is to be able to justify 1000 hours at an hourly rate of $X, if her duties are very light, then $20k-$25k is an appropriate salary. If she got $150k as an example not doing much, THAT would be a much fatter target of an IRS audit. Usually small practices who employ spouses pay them around $20k-$30k, more if they actually have big roles as say office manager. So the first thing I ask the CPAs is, how high of a W2 can you legally justify for the spouse, as that sometimes can make a big difference as they can max out a 401k plan (and put a big chunk in a CB plan as well). But this has to be supported somehow as you don't just pay $150k to a spouse that doesn't do anything.

That said, just paying them to zero out their take home is a bit strange. I mean, you end up getting close to zero with these low W2s anyway. But that, in and of itself is not really a big deal. Whether the W2 is $20k or $21,115 is not going to be an issue as much as whether the spouse works 1000 hours and is actually eligible to participate.