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rules that had generally limited the contribution and benefit amounts of owners and spouses in a common plan  were repealed as of January 1, 1997.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

• Business income available for payment of services rendered

• The extent of the plan contribution based on payment for services rendered

• The cost attributable to FICA taxes (Social Security and Medicare) by both the business and the spouse (and the relatively small cost for FUTA or SUTA taxes)

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 Study 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 $17,000 and contribute $15,000 to the plan (the additional income above $15,000 is necessary to permit the spouse to pay the FICA, FUTA and SUTA taxes). 

If the spouse is age 50 or older, the availability of the new 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 $22,000 and contribute $20,000 to the plan (the additional income above $20,000 is necessary to permit the spouse to pay the FICA , FUTA and SUTA taxes).

In addition, the increases in the maximum individual contribution limits to the lesser of 100% of compensation or $44,000, the increase in the limit on maximum individual compensation used in determining contributions to $220,000 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.  Click here to view Case Study illustrating a $44,000 plan contribution for a spouse earning $44,000

The cost attributable to FICA taxes (Social Security and Medicare) by both 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 here to view complete Case Study considered in this analysis

FICA Tax Analysis - Owner's self-employment income: $50,000

Spouse W-2 total compensation:      

FICA paid by employee (7.65%):      

FICA paid by employer (5.74% in 25% bracket)

Total FICA tax 

FICA Tax Savings by adding spouse 

Net additional FICA Tax Cost                    

Plan contribution (100% of compensation)    

Tax Savings (25% bracket)

Positive Outcome: No additional FICA, $4,250 tax savings, shelter $17,000

Click here to view complete Case Study considered in this analysis

FICA Tax Analysis - Owner's W-2 income: $220,000

Spouse W-2 total compensation:      

FICA paid by employee (7.65%):      

FICA paid by employer (4.97% in 35% bracket)

Total FICA tax 

Medicare Tax Savings by adding spouse 

Net additional FICA Tax Cost                    

Plan contribution (100% of compensation)    

Tax Savings (35% bracket)

Positive Outcome: $4,501 FICA tax, $15,400 tax savings, shelter $44,000

Click here to view complete Case Study considered in this analysis

 FICA Tax Analysis - Owner's self-employment income: $50,000

Spouse W-2 total compensation:          

FICA paid by employee (7.65%):      

FICA paid by employer (4.97% in 25% bracket)

Total FICA tax 

FICA Savings by adding spouse 

Net additional FICA Tax Cost                    

Total contribution for Spouse    

Tax Savings (25% bracket)

Positive Outcome:  No additional FICA, $5,500 tax savings, shelter $22,000

Click here to view complete Case Study considered in this analysis

FICA Tax Analysis - Owner's W-2 income: $220,000

Spouse W-2 total compensation:          

FICA paid by employee (7.65%):      

FICA paid by employer (4.97% in 35% bracket)

Total FICA tax 

Medicare Tax Savings by adding spouse 

Net additional FICA Tax Cost                    

Total contribution for Spouse (Age >50)  

Tax Savings (35% bracket)

Positive Outcome: $4,013 FICA tax, $17,150 tax savings, shelter $49,000

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 by the examples above), the specific business profile (owner income, number of eligible employees, etc.) and the extent of spouse income has a significant impact on the outcome of the analysis. 

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