Is your spouse your employee?
One of the advantages of operating your own business is hiring family members. However, the employment tax requirements for family employees can vary from those that apply to other employees. There are a couple of different ways a married couple can operate a business together.
If you operate a sole proprietorship and you hire your spouse as an employee, you have an employee/employer relationship. This means one spouse substantially controls the business in terms of management decisions and the other spouse is under his or her direction and control. If such a relationship exists, then the non-owner spouse is an employee subject to income tax withholding, social security and Medicare tax, but not to FUTA tax. If this type of arrangement exists, you can provide benefits to your spouse and deduct them on your business return. One of these benefits can be health insurance. If your spouse is a bona-fide employee and is paid a reasonable wage for the services that he or she performs, you can provide health insurance to your spouse with a policy that covers both of you. This way you are allowed a deduction for the coverage on your business return and, in turn, reduce your self-employment tax. You can also provide retirement benefits to your spouse.
On the other hand, if your spouse has an equal say in the business affairs, provides substantially equal services to the business, and contributes capital to the business, then a partnership relationship exists and the business’s income should be reported on Form 1065. When spouses carry on a business together and share in the profits and losses, they are partners in a partnership regardless of whether they have a formal partnership agreement. They should not report the income on a Form 1040, Schedule C, in the name of one spouse as a sole proprietor nor should they file a joint Schedule C. In a partnership, each spouse reports their separate share of the partnership income and pays their own self-employment tax. This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based.