NASE Blogs

Tax Deductions and Hiring Your Spouse

May 25, 2010

Q: I attended the TaxTalk seminar in Casper, WY, in March. You mentioned some tax perks to hiring your spouse. Can you explain that to me?


A: The key benefit to hiring your spouse is related to the benefits of a Health Reimbursement Arrangement used to maximize the pre-tax payment of medical expenses. For about the last 25 years, the IRS has allowed small businesses to adopt Heath Reimbursement Accounts for their employees as authorized under Internal Revenue Code Section 105. The NASE HRA 105 plan is such a plan, thus the name 105. These Plans allow for your business to pay for things like insurance premiums, dental care, eye care, prescription drugs, etc, on behalf of your employees. The costs are deductible to your business but are not taxable income to the employee. This is the same concept that big businesses use in Section 125 plans (cafeteria plans) and Medical Spending Accounts (MSA’s). The small-business owner who currently has no employees but does have a spouse that helps in the business achieves the biggest benefit. The owner hires their spouse and adopts an HRA Plan that covers all of the family’s medical costs. Because of the adopted Plan, all of the family’s medical costs are now 100% deductible, instead of only the health insurance premiums.

If you normally have out of pocket costs of about $400 per month, for example (health insurance premiums alone can be that high) your tax savings could be $2,000 or higher. So, if you spent $400 per month or $4,800 per year and are in the 28% tax bracket, you will save 28% in federal taxes or $1,344 and 15.3% in self-employment taxes or $734 for a total of $2,078. Remember that you save not only on federal taxes but also on your self-employment taxes and on state taxes, if your state has a state tax. Your state tax rate could save you another 3% to 5%. Also, don’t forget that this $4,800 is money that you are going to spend whether you have a plan or not, so the $2,000 savings is totally a result of the plan. The benefit is only available to employees; therefore, the small-business owner operating as a sole proprietorship will not be able to deduct their own expenses, but only those of their employees. This is why they would need to hire their spouse as an employee in order to take advantage of the plan.

The practical process for the expense is that the employee pays the qualified expenses personally and then submits a request for reimbursement. This is similar to submitting an expense reimbursement request at work for business items that you may have paid for. The business then issues a check to the employee to reimburse them for the expense. The expense is now a deduction for the company and is supported by the request for reimbursement. The amount would be included on line 14, Employee Benefit Programs on the Schedule C, Profit or Loss from Business.

Another key point is that neither the IRS nor the Department of Labor has an annual filing requirement. Larger companies file an annual form 5500 for their benefit plans, which can be complicated. HRAs have no such filing requirement. The IRS, however, does require that the plan be in writing and be nondiscriminatory. You can log read more about the free plan the NASE offers here.