What Is It?
Reducing (or eliminating) spousal compensation is a strategy you can use to minimize the Social Security taxes you pay if you own a business and run it with your husband or wife. By reducing or eliminating the salary one spouse receives, you can avoid paying double payroll taxes.
Who May Benefit From Using This Strategy?
Spouses Who Expect To Receive a Spousal Social Security Retirement Benefit
Spouses who run a business together may benefit from eliminating spousal compensation if one spouse expects to eventually receive a Social Security retirement benefit based on the other spouse's primary insurance amount (PIA).
Example(s): Gail and Dale run a business together. Gail's PIA is $1,200, and Dale's is only $500. When they both retire next year, Dale will receive a benefit based on Gail's PIA because that will result in a benefit higher than one based on his own PIA ($600 versus $500). Any Social Security taxes Dale pays between now and then will be, in effect, wasted, so Dale stops taking compensation.
Spouses Who Own a Corporation
Although owners of sole proprietorships and partnerships pay self-employment taxes, owners of corporations are treated as employees of the corporation and pay Social Security payroll taxes on their salaries. However, a husband, for example, could elect to receive dividend income from the business instead of salary, while his wife receives a salary. This would save one-half of their payroll taxes because dividends paid by a business are considered investment income and thus are not subject to Social Security payroll taxes.
Owners of Sole Proprietorships
If you own a sole proprietorship, your spouse may work with you or for you in your business. When you and your spouse work together, you can save money by keeping your spouse off the payroll. Your spouse will be, in effect, a volunteer, and you will not have to pay Social Security payroll taxes on his or her salary.
Business Owners Can Save a Lot of Money in Taxes by Reducing or Eliminating Spousal Compensation
Not only can the business owner save Social Security taxes, but he or she will save other taxes that an employer must pay, such as unemployment insurance and disability and workers' compensation insurance premiums.
- The IRS frowns on business owners receiving dividend compensation in lieu of salary.
- A working but noncompensated spouse won't get credit for Social Security purposes. This could be a problem if the spouse has not already qualified for coverage, especially if the spouses divorce or if the other spouse dies.
- A working but noncompensated spouse may be ineligible to receive company benefits, but this might not be a problem if the benefit plan (such as a health insurance plan) covers spouses.
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