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Adding a Spouse to Qualified Retirement Plan - January 1, 2002 (updated to reflect new limits on January 1, 2004)

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rules that had generally limited the contribution and benefit amounts of owners and spouses in a common plan  were repealed as of January 1, 1997.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 $14,500 and contribute $12,000 to the plan (the additional income above $13,000 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 $17,500 and contribute $16,000 to the plan (the additional income above $16,000 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 $41,000, the increase in the limit on maximum individual compensation used in determining contributions to $205,000 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 $41,000 plan contribution for a spouse earning $41,000

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:      

 $14,500  

FICA paid by employee (7.65%):      

1,109  

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

     832  

Total FICA tax 

  $  1,941  

FICA Tax Savings by adding spouse 

  (1,941)  

Net additional FICA Tax Cost                    

$        0  

Plan contribution (100% of compensation)    

 $14,500  

Tax Savings (25% bracket)

  $  3,625  

Positive Outcome: No additional FICA, $3,625 tax savings, shelter $14,500

Click here to view complete Case Study considered in this analysis

FICA Tax Analysis - Owner's W-2 income: $205,000

Spouse W-2 total compensation:      

 $41,000  

FICA paid by employee (7.65%):      

3,337  

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

    2,039  

Total FICA tax 

  $  5,376  

Medicare Tax Savings by adding spouse 

  (981)  

Net additional FICA Tax Cost                    

$  4,395  

Plan contribution (100% of compensation)    

 $41,000  

Tax Savings (35% bracket)

  $14,350  

Positive Outcome: $4,395 FICA tax, $14,350 tax savings, shelter $41,000

Click here to view complete Case Study considered in this analysis (uses 2002 limits; analysis below uses 2004 limits)

FICA Tax Analysis - Owner's W-2 income: $205,000

Spouse W-2 total compensation:          

 $14,500  

FICA paid by employee (7.65%):      

1,109  

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

    721  

Total FICA tax 

  $  1,830  

Medicare Tax Savings by adding spouse 

  (346)  

Net additional FICA Tax Cost                    

$  1,484  

Total contribution for Spouse    

 $14,500  

Tax Savings (35% bracket)

  $ 5,075  

Positive Outcome: $1,484 FICA tax, $5,075 tax savings, shelter $14,500

Same case study but Spouse earns $41,000 versus $14,500

FICA Tax Analysis - Owner's W-2 income: $205,000

Spouse W-2 total compensation:      

 $41,000  

FICA paid by employee (7.65%):      

3,337  

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

    2,039  

Total FICA tax 

  $  5,376  

Medicare Tax Savings by adding spouse 

  (981)  

Net additional FICA Tax Cost                    

$  4,395  

Total contribution for Spouse    

 $15,020  

Tax Savings (35% bracket)

  $5,075  

Questionable Outcome: $4,395 FICA tax, $5,075 tax savings, shelter $15,020

Click here to view complete Case Study considered in this analysis (uses 2003 limits; analysis below uses 2004 limits)

FICA Tax Analysis - Owner's W-2 income: $205,000

Spouse W-2 total compensation:          

 $17,500  

FICA paid by employee (7.65%):      

1,339  

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

    870  

Total FICA tax 

  $  2,209  

Medicare Tax Savings by adding spouse 

  (418)  

Net additional FICA Tax Cost                    

$  1,791  

Total contribution for Spouse (Age >50)  

 $16,822  

Tax Savings (35% bracket)

  $ 5,888  

Positive Outcome: $1,791 FICA tax, $5,888 tax savings, shelter $16,822

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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2002-2004 Milberg Consulting LLC  All Rights Reserved

We intend the information in this publication as a general resource, not as legal or plan compliance advice or counsel. If you consider any actions discussed in this update, we suggest that you consult a tax or ERISA professional. Milberg Consulting LLC and Barry R. Milberg do not warrant and are not responsible for any errors and omissions from this update.