How to Pay Your Spouse From a Single-Member LLC Properly

Running a single-member LLC comes with unique challenges, particularly when compensating your spouse for their contributions to the business. Properly structuring payments has legal and tax implications that require careful attention.

Understanding how to classify and pay your spouse is essential for compliance and financial efficiency. This guide outlines key considerations and best practices to manage these payments effectively.

Determining Employment Classification

The first step is to determine whether your spouse should be classified as an employee or an independent contractor, as each classification carries distinct legal and tax implications. The IRS evaluates factors such as the degree of control over how work is performed and the financial relationship. If you dictate hours, location, and the nature of the work, your spouse is likely an employee. If they have autonomy and supply their own tools, they may qualify as an independent contractor.

Classification impacts tax obligations and benefits eligibility. Employees may qualify for benefits like health insurance and retirement plans, while independent contractors handle their own taxes and benefits. Misclassification can lead to penalties, so it’s important to assess the working relationship carefully. If uncertain, IRS Form SS-8 can provide a formal determination of worker status.

Approaches to Paying a Spouse

Compensating a spouse requires aligning with business goals and regulatory requirements. A common approach is paying a regular salary as an employee, which involves establishing a payroll system. This ensures consistent payments and proper tax withholding, such as federal income tax, Social Security, and Medicare. Additionally, paying a salary can help optimize retirement contributions through plans like a SEP IRA or Solo 401(k).

Alternatively, paying your spouse as an independent contractor offers flexibility and typically involves issuing a 1099-NEC form at year-end. While this reduces payroll tax administration, it requires thorough documentation to support the independent contractor classification. Clear records of services, payment terms, and agreements are critical to avoiding IRS scrutiny.

Withholding and Payroll Obligations

Setting up a compliant payroll system is essential when paying a spouse as an employee. Federal income tax withholding is determined by the W-4 form, and FICA taxes—Social Security (6.2%) and Medicare (1.45%)—must be withheld from both employer and employee. Stay updated on annual thresholds like the Social Security wage base to ensure accuracy.

State and local taxes also apply, and requirements vary by jurisdiction. Some states, such as California, mandate additional payroll taxes like disability insurance. Timely filing of tax returns, such as IRS Form 941 for quarterly federal tax withholding, is critical to avoid penalties.

For spouses classified as independent contractors, withholding is not required, but accurate records of payments and services provided are necessary. Properly preparing and filing Form 1099-NEC ensures compliance.

Tax Reporting Requirements

Tax reporting for spouse compensation demands accuracy. For employees, wages must be reported on Form W-2, detailing income, taxes withheld, and deductions. This form must be provided to the employee and filed with the Social Security Administration by January 31 of the following year.

Independent contractor payments are reported on Form 1099-NEC, which outlines non-employee compensation for the year. This form must also be submitted to the IRS and the contractor by January 31. Late filings can incur penalties ranging from $50 to $290 per form, depending on the delay’s duration.

Recordkeeping and Compliance

Maintaining detailed records is essential to managing payments to a spouse and ensuring compliance. The IRS often scrutinizes transactions involving family members, making it crucial to document employment agreements, time sheets, and payment records. For employees, retain payroll registers, W-2 forms, and proof of tax withholdings. For independent contractors, keep signed contracts, invoices, and 1099-NEC forms.

Track benefits provided, such as health insurance or retirement contributions, documenting payment amounts, dates, and justifications. For example, if your spouse participates in a health plan through the LLC, ensure compliance with laws like the Affordable Care Act (ACA) and accurate recordkeeping of contributions.

Compliance also involves adhering to federal and state labor laws. Wages paid to a spouse must meet minimum wage requirements under the Fair Labor Standards Act (FLSA), and overtime rules must be followed if applicable. State-specific regulations, such as those for paid leave or workers’ compensation, must also be observed. Regularly reviewing compliance checklists and consulting professionals can help mitigate risks and ensure the LLC operates within legal boundaries.