Should I Add My Spouse to the Payroll?
Social Security can be a tricky subject for many especially with the added complexity for small business owners dealing with payroll. What if your spouse is the small business owner? How can you leverage business ownership to assist your spouse in his/her Social Security claiming strategy? What is your and your family’s eligibility for Social Security since your earnings/losses may have been erratic over the years? How does your decision affect self-employment taxes? Most people have heard that your spouse is entitled to up to 50% of your benefit amount, but what if your spouse was eligible for their own benefit as an employee of your business…could they earn more?
Options Owners Consider:
There are a few ways a salary can be arranged:
- The business owner might add the spouse to the payroll and pay a minimal salary to give a basic Social Security eligibility on their own work record.
- He/she might pay them both a high salary in order to maximize both spouses’ respective Social Security benefits.
- Once the working spouse has qualified for a fairly high benefit, perhaps they might swap out their own high salary and pay themselves little or nothing while paying the non-working spouse enough to give them more than the minimal Social Security benefit.
There is also the question of how much business owners should pay themselves in salary to begin with, regardless of how it is divided up between them. At its core, the question is about the return on investment a business owner might receive in exchange for paying self-employment taxes.
These self-employment (SE) taxes are consequential. Business owners pay both the employee’s and the employer’s share of Social Security and Medicare taxes. Social Security taxes are 12.4% on salaries up to $127,200 in 2017. Medicare taxes are 2.9% on all salaries, with an additional 0.9% on a salary over $250,000 for married couples. It definitely pays to minimize Medicare taxes because benefits do not increase with the payment of higher taxes.
Adding Your Spouse to the Payroll
As long as you have earned enough credits, you will qualify for premium-free Medicare Part A and the ability to purchase Part B of Medicare by paying its monthly premium. Social Security, however, is a different story. Social Security’s progressive formula means that the more you earn, the higher your benefit will be. But will your benefit be high enough to justify paying the higher SE taxes? The answer is no. The payment of self-employment taxes for a spouse over a 10-year period of time does not result in a Social security benefit that is higher than the spousal benefit to justify paying the SE taxes. It is essentially money down the drain. As for the main business owner, the payment of SE taxes provides diminishing returns over time; this is because the last tier of earnings is not attributed to one’s monthly benefit amount at the same rate as other income levels (only 15%).
The following is a client illustration:
Let’s look at a hypothetical couple, Jerry and Jane, both 55 years old.
Jerry has paid himself the maximum Social Security wage base since he was 30. Jane has drawn no salary at all.
If Jerry continues to pay himself the Social Security wage base until he is 66, his primary insurance amount (PIA), or the benefit he will receive if he files for it at full retirement age, will be $2,824 in today’s dollars, according to the SSA Detailed Calculator.
If Jane reaches full retirement age (FRA) with no earnings record of her own, she will be entitled to a spousal benefit of 50% of Jerry’s PIA, or $1,412. Their combined benefit at full retirement age will be $4,236.
If Jerry continues to pay himself the maximum wage base and adds Jane to the payroll at $20,000 a year for the next ten years, Jane’s PIA on her own work record will be just $428, which is well below the spousal benefit.This would also cost them more than$30,000 in self-employment taxes on Jane’s salary with no bump in Social Security benefits.
If Jane goes onto the payroll at maximum salary, she could build her PIA up to $1,399. If Jerry is also receiving maximum salary, they would have a combined monthly benefit of $4,223 ($2,824 + $1,399). This is slightly less than what they would receive if Jane just received a spousal benefit without taking any salary: $4,223 vs.$4,236. However,they would have paid about $170,000 in additional self-employment taxes on her salary.
What if Jerry stops paying himself while paying Jane the maximum Social Security wage base for the next 10 years? This will not cost them any additional SE taxes because they are just assigning Jerry’s salary to her. Now Jane’s PIA will be the$1,399, but Jerry’s PIA will drop to $2,443, for a total benefit of$3,842.
Compared to the status quo, where Jerry receives maximum salary while Jane receives no salary, assigning the salary to Jane would net them a lower monthly benefit: $3,842 vs. $4,236. It would also reduce Jane’s survivor benefit if Jerry dies first: $2,443 vs. $2,824 (or $3,016 vs. $3,502 if he delays to age 70).
So the clear conclusion in this hypothetical case is that it would not be worth it for Jane to start drawing a salary.
- If they pay Jane a minimal salary, they would pay additional SE taxes for a benefit she can’t use.
- Even if they pay her a high salary, it would cost an additional $170,000 in SE taxes without increasing the spousal benefit as if she hadn’t worked.
- If they stop paying Jerry and assign his salary to her, there would be no additional SE taxes, but it would lower their combined monthly benefit and significantly reduce her survivor benefit. In Jerry’s case, that last ten years of salary cost him $170,000 in SE taxes and netted him only $381 in additional monthly benefits.