Paying yourself

Putting your spouse on payroll, and when it backfires

Your spouse does real work in the business and is not on the books. Adding them can open up retirement and benefits. It can also just add payroll tax to money that was already being taxed efficiently.

In a lot of small businesses one spouse runs the operation and the other one quietly does a job. Bookkeeping, scheduling, the website, the part of the business nobody sees. They have never been paid for it because the money is joint anyway.

Then somebody suggests putting them on payroll, and it gets presented as an obvious win. Sometimes it is. Often enough it costs money, and the reason is simple arithmetic that nobody runs before starting.

The misconception

The belief is that adding a family member to payroll always saves tax because it creates a deduction. On a joint return that logic breaks immediately. A wage the business deducts is a wage the household reports. The income tax on it largely washes out.

What is actually happening

What does not wash out is employment tax. Wages carry it on both sides, and in a pass-through where the profit was already going to be taxed to you, converting some of that profit into a spousal wage can add employment tax that was not there before.

Against that sit real benefits. A wage creates earned income, which can support retirement contributions in the spouse's name, both their own deferral and an employer contribution. It can bring them into a health plan or other benefits the business offers. Over a long enough horizon it can affect their own future benefit entitlements.

It is a trade, not a saving, and the trade goes different ways in different households.

So the question is never whether to put a spouse on payroll. It is whether the benefits you would actually use are worth more than the employment tax you would actually pay.

The number

This one moves in both directions, which is why I will not give you a single figure. Where the household will genuinely fund retirement contributions that could not otherwise be made, the benefit can be substantial relative to the added tax. Where the contributions were going to happen anyway through another route, the added employment tax is often a straight annual loss.

The size of both sides depends on your profit, the wage level, your other income, your entity type, the plan you run and your state. Contribution limits and wage bases change over time, so any comparison needs to be run against the current year rather than against a number you remember.

What it actually requires

If the comparison comes out in favour, the execution is ordinary and not optional:

• Genuine work, describable as a role someone else could be hired to do
• A reasonable rate for that role in your market, not a figure reverse-engineered from a contribution limit
• Real payroll with the filings and deposits that go with it
• A retirement plan document if the contributions are part of the reason
• Benefits applied consistently, not offered only to the spouse

That last point catches owners who set up a plan or a benefit purely for the family and forget that having other employees changes what the business is obliged to offer them.

Who this is not for

This is the common case, so read it carefully. If your household is not going to make the retirement contributions, does not need the health coverage through the business, and is already comfortable on the benefit entitlement side, then putting a spouse on payroll adds employment tax and payroll administration and gives you very little back.

It is also not for a spouse who does not genuinely work in the business. A wage without work is the same problem as any other wage without work, and being married does not soften it.

And it is usually wrong when the wage is set to hit a contribution target rather than to reflect the job. The rate has to make sense on its own. If it only makes sense as a route to a plan contribution, you have built the position backwards and it reads that way from outside.

The timing

Run the comparison before the first payroll of the year. Starting mid-year is possible but it makes the arithmetic messier, and stopping partway through a year leaves you with a part-year wage, a part-year plan and a set of filings that do not tell a clean story.

This is a planning question

Nothing here can be decided in filing season, because by then the payroll either ran or it did not and the contributions either happened or they are gone. This is a modelling exercise done in advance, on your household's actual numbers, with someone who is willing to tell you when the answer is no.

This is general information, not advice on your own situation. Whether any of it applies to you depends on facts this article does not know.