Adding a Spouse to a Qualified Plan
January 1, 2009 (updated of January 1, 2002 article to reflect 2007 limits)
Spouses working for family owned or closely-held business are oftentimes excluded from the business's qualified retirement plan due to the 15.3% of compensation cost attributable to FICA taxes (7.65% deductible Social Security and Medicare taxes paid by the business and 7.65% non-deductible taxes paid by employee). In addition, many business owners remain unaware that onerous family aggregation rules that had generally limited the contribution and benefit amounts of owners and spouses in a common plan were repealed as of January 1, 1997.
Starting in 2002, the increase in the individual 401(k) deferral limit, the availability of the new 401(k) "catch-up" contributions, the increases in the maximum individual contribution/benefit limits, the increase in the limit on maximum individual compensation used in determining contributions/benefits, and in the employer deduction limits, provide significant new planning opportunities relative to the inclusion of a spouse in the qualified retirement plan of the family owned or closely-held business.
The purpose of this article is to explore the factors involved in the considering the inclusion of a business owner's spouse in the qualified retirement plan sponsored by the family business. In the context of this discussion, a business is any employer including an independent contractor, or a single or multiple owner business entity (self-employed individual or partnership, subchapter "C" or "S" corporation, LLC or LLP) whether or not the business entity employs any common law employees (typically an employee who receives W-2 income form the employer).
The factors to consider relative to the inclusion of the spouse are:
Justification and extent of compensation for services rendered
Compensation paid to an employee is deductible as a business expense only if services are rendered in connection with such payment. In addition, the amount of compensation paid must be considered reasonable in light of the type of services rendered.
Business income available for payment of services rendered
Although services rendered by a spouse may be considered as justifiable for purposes of the deductibility of compensation, the business may not have adequate income to provide payment. The benefits provided by this planning opportunity may induce the business owner to consider a less aggressive stance relative to the deduction of certain business expenses, thereby providing additional business income provide compensation to the spouse for services rendered. Click here to view Case Studies illustrating the benefit of including a spouse in lieu of aggressive deduction of business expenses.
The extent of the plan contribution based on payment for services rendered
The increase in the individual 401(k) deferral limit permits the spouse to contribute 100% of compensation to the business's qualified retirement plan. This means that the spouse can earn as little as $18,000 and contribute $16,500 to the plan (the additional income above $16,500 is necessary to permit the spouse to pay the applicable portion of FICA, FUTA and SUTA taxes). View case study
If the spouse is age 50 or older, the availability of the 401(k) "catch-up" contribution permits the spouse to contribute 100% of compensation to the business's qualified retirement plan. This means that the spouse can earn as little as $24,000 and contribute $22,000 to the plan (the additional income above $22,000 is necessary to permit the spouse to pay the applicable portion of FICA, FUTA and SUTA taxes). View case study
In addition, the increases in the maximum individual contribution limits to the lesser of 100% of compensation or $49,000, the increase in the limit on maximum individual compensation used in determining contributions to $245,000 and in the increase in the employer profit sharing deduction limit to 25% allow spouses to contribute significant amounts to plans while minimizing the taxable income necessary to provide maximum benefits. View case study
The cost attributable to FICA taxes (Social Security and Medicare) payable by the business and the spouse
The key factor in considering the addition of the spouse is the 15.3% of compensation cost attributable to FICA taxes (7.65% deductible Social Security and Medicare taxes paid by the business and 7.65% non-deductible taxes paid by employee) as well as the relatively small cost for FUTA or SUTA taxes. The analysis must consider the amount of the contribution, and the compensation earned by the spouse and the business owner.
Click on the case study below to view the applicable FICA tax analysis:
Bottom Line In general, the additional FICA tax required by adding a spouse to the plan is justified by the increase in tax deductible plan contributions. However (as illustrated in the case studies), the specific business profile (owner income, number of eligible employees, etc.) and the extent of spousal income impacts the FICA tax analysis outcome.
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The information provided is intended as a general resource, not as investment or retirement planning, or legal plan compliance advice or counsel. If you consider any actions discussed in this update, we suggest that you consult a qualified planning, tax or ERISA professional. ERISA Expertise LLC and Barry R. Milberg do not warrant and are not responsible for any errors and omissions from this update. Any tax advice included in this written or electronic communication is not intended or written to be used, and it cannot be used, by the taxpayer for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.