Best way to pay wife

[ShahMD]

Hey all. Independent ER doc here. I was curious as to the best way / amount to pay my wife.
She helps with lots of admin duties/scheduling/accounting issues for me. She is currently unemployed.
I want her to be able to max out her employee contribution for 401k of $18500 for 2018.
Could I just pay her $18,500 for 2018 (it being a business expense for my S Corp and she being another independent contractor with her own EIN?) That way she can take the entire amount and dump it into a Solo401k?
Is there taxes to pay? If there is, what would be the minimum amount to “pay” so she can max out 401k but that we could enjoy some tax free investing?
Please advise. Thank you all so much.

[spiritrider]

Some issues.

It is generally not possible to justify classifying a spouse or children as an IC. The IRS has held that they would fail all three categories of Behavioral Control, Financial Control and Relationship of the Parties, used in determining employee vs. IC designation.

Also, there would be no requirement for her to be an IC for retirement plan purposes anyway. As a spouse employee she is an eligible participant to open a 401k account under a one-participant 401k, make a deferral and receive employer contributions.

In order for her to make an employee deferral of $18,500 and you to provide her with an employer contribution of $4,625. You would need to pay her a minimum of $20,032.50. This is because deferrals must be deducted from payroll after mandatory deductions. This would be at least FICA.

The above statement is in error. $20,032.50 would allow the maximum employee deferral after accounting for FICA, but the maximum employer contribution would be $20,032.50 - $18,500 - $1,532.50. In order for her to have 100% of her income as employee + employer contributions it would have to be $23,125 ($18,500 * 1.25).

However, you must pay her a Fair Market Value (FMV) wage and her work hours must be justified by the actual tasks required. Let's say that you pay her $400/week = $20,800. Do you think with the FMV and tasks required. That you can justify 20 hours/week at $20/hour or 16 hours/week at $25/hour?

[jfoxcpacfp]

This is not "tax-free" money. Be aware that, if you hire your wife, you will be trading income that is not taxed for FICA purposes for income that is taxed 100% at FICA tax rates (7.65 each for business and also withheld from your wife's paycheck). That is because your S-corp would be paying her wages from profits of the business which are otherwise taxed for income tax purposes only. iow, her 401k would be starting out with a 15.3% tax penalty to earn back before you break even on the account.

Is it possible a taxable account could be better? While you would get an up-front deduction for her 401k, you'll be paying taxes at your top marginal rate when the money comes out. With a taxable account, you'll have "basis" in your investments and pay preferential tax rates on long-term capital gains and qualified dividends.

[ShahMD]

Thank you both for explaining. I greatly appreciate it. It seems like just putting the money into a taxable account is a better idea. It's a little weird that all my friends "hire" their wives. It sounds like its kind of a wash then unless there's something I'm missing. Thanks again for explaining.

[q-school]

ShahMD wrote:

Thank you both for explaining. I greatly appreciate it. It seems like just putting the money into a taxable account is a better idea. It’s a little weird that all my friends “hire” their wives. It sounds like its kind of a wash then unless there’s something I’m missing. Thanks again for explaining.

Click to expand...

ah yes, the friends do it strategy. 

 

[DMFA]

You're on the hook for 15.3% SS and Medicare one way or the other. So you're deducting 37% (assuming top bracket) to pay 15.3% now and pay 22% or so on it in retirement...

I guess that's more benefit than deducting nothing now, paying 15-20% in the future, plus dividends/CGs along the way...but the payroll taxes make it not as much benefit as it might initially seem.

[spiritrider]

It rarely makes financial sense to "hire" spouses just for 401k contribution purposes. That is why I made a big point of justifying the need based on tasks. However, all things are not always about the bottom line.

The 15.3% can be considered a cheap investment in the marriage if there are real tasks for her to do and she wants to do them. Don't underestimate the value of her feeling as though she is part of the effort to bring in your income, earn income herself and have her own retirement investments. Just be aware that women have a sixth sense about being pandered to.

The real financial benefit is to hire your children when they get older. Unlike a spouse's wages which still are part of the joint income. With children you are moving income taxed at your top marginal rate to probably 0% to offset FICA. Only* in businesses taxed as a sole proprietorship or a partnership where the parents are the only partners. There is no FICA < 18 and no FUTA < 21 for children of the owners. Remember, they must get a FMV wage and the hours justified.

*Some tax specialists have taken the position that you can create a "family management company" operated as a sole proprietorship. Have the management company employ the kids and the S-Corp leases them from the management company. I am not entirely convinced this is allowed. Maybe Johanna can comment.

[jfoxcpacfp]

DMFA wrote:

You’re on the hook for 15.3% SS and Medicare one way or the other. So you’re deducting 37% (assuming top bracket) to pay 15.3% now and pay 22% or so on it in retirement…

I guess that’s more benefit than deducting nothing now, paying 15-20% in the future, plus dividends/CGs along the way…but the payroll taxes make it not as much benefit as it might initially seem.

Click to expand...

Yes, so he's paying an extra 15.3% to grow the solo-k tax-deferred. And we haven't mentioned unemployment and possible local payroll taxes.

[jfoxcpacfp]

 

spiritrider wrote:

*Some tax specialists have taken the position that you can create a “family management company” operated as a sole proprietorship. Have the management company employ the kids and the S-Corp leases them from the management company. I am not entirely convinced this is allowed. Maybe Johanna can comment.

Click to expand...

I had to google this. I don't believe it is something I would suggest to a client. Now, if a client brought it up and wanted to explore the idea, I might entertain it. But I would make full disclosure of the inherent risks that I perceive along with the added cost of administration (primarily CPA fees).

[spiritrider]

Yes, it seems too cute by half to me. They only reason I know about this is because I know an S-Corp using it (I had to google it too) It seems like an aggressive position to take. Yet their CPA swears by it.

[jfoxcpacfp]

spiritrider wrote:

Yes, it seems too cute by half to me. They only reason I know about this is because I know an S-Corps using it (I had to google it too) It seems like an aggressive position to take. Yet their CPA swears by it.

Click to expand...

Easy to swear by a position until you've been tried by fire. Has the IRS gone to court over this yet?

[spiritrider]

I haven't found any IRS guidance or tax court rulings one way or another on this specific issue, but then again there is nothing on Backdoor Roths either.

However, just a year ago the U.S. Sixth Circuit Court of Appeals stated in a related ruling; "The Commissioner cannot fault taxpayers for making the most of the tax-minimizing opportunities Congress created."

This obviously is a tax minimizing opportunity. Th rub has always been is it more like tax avoidance or more like tax evasion.

 

 

[The White Coat Investor]

ShahMD wrote:

Thank you both for explaining. I greatly appreciate it. It seems like just putting the money into a taxable account is a better idea. It’s a little weird that all my friends “hire” their wives. It sounds like its kind of a wash then unless there’s something I’m missing. Thanks again for explaining.

Click to expand...

The only real benefit is another retirement account, so you're weighing that against the additional payroll taxes. My wife owns half of WCI, LLC, but she's definitely earning her money these days. Another potential benefit is increasing the new pass thru deduction, but that's highly dependent on a lot of other factors as to whether just adding an employee will increase that.

[spiritrider]

If you have previously read this thread. I made an error in my January 30, 2018 at 9:01 am MST post. Please refer to it for the correction and double check my entry.