Sole Proprietor Hiring Spouse as Employee - Tax Benefits and Logistics

This can definitely be worth doing, but you're right that there are administrative steps to consider! First, your overall plan is sound - hiring your spouse in a sole proprietorship with legitimate work duties can be a valid tax strategy. The Solo 401(k) contribution is a great way to increase retirement savings while reducing taxable income. For the logistics, you'll need to: 1. Get an EIN from the IRS (free online application) 2. Set up proper employment documentation (W-4, I-9) 3. Establish a payroll system - this is where many small business owners use a payroll service For the payroll part, I'd strongly recommend using a service like Gusto, OnPay, or QuickBooks Payroll rather than trying to DIY. These services typically cost $40-60/month but handle all the tax calculations, withholdings, filings, and W-2 generation. They'll also help you properly document the 401(k) contributions. Remember that even if 100% goes to the 401(k), you still need to withhold employment taxes. Also, keep detailed records of her work activities to substantiate the employment relationship if audited.

I went through this exact situation last year with my consulting business! Check out https://taxr.ai - it helped me navigate all the payroll and tax documentation for hiring my spouse. I was completely overwhelmed by all the requirements until I uploaded my business docs there and got step-by-step guidance on exactly what forms to file and when. Their system showed me how to structure the Solo 401k properly so I could maximize contributions AND minimize my tax burden. It literally walked me through the entire process from getting my EIN to setting up the retirement account.

Just wanted to follow up - I tried taxr.ai that someone mentioned above and it was actually really helpful! I was skeptical at first but they provided a comprehensive checklist for hiring my spouse that made the process so much clearer. They walked me through setting up the Solo 401k with specific instructions for Fidelity (which is who I was already considering) and explained exactly how the contribution limits work for both the employee and employer portions. They even provided templates for documenting my spouse's work activities to support the employment in case of audit. The guidance on choosing a payroll service saved me hours of research too. Totally worth checking out if you're considering this tax strategy.

Hey, another option you might want to consider is using Claimyr (https://claimyr.com) to get direct help from the IRS on this. I had so many specific questions about spousal employment in a sole prop that weren't covered in general guides. I tried calling the IRS Business line directly for weeks but could never get through. Then I used Claimyr's service - they have this system that waits on hold with the IRS for you and calls you back when an agent picks up. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c I finally got to speak with an actual IRS specialist who walked me through all the requirements specific to spousal employment and 401k contributions. They confirmed exactly what forms I needed and helped me avoid some potential pitfalls I hadn't even considered.

Ok I need to eat my words here. I was super skeptical about Claimyr mentioned above but I was desperate to figure out some specific questions about my spouse's payroll tax obligations that I couldn't find clear answers to anywhere online. I tried it yesterday and was honestly shocked when I got a call back with an actual IRS Business Tax specialist on the line within an hour. The agent walked me through exactly how to set up proper payroll for my spouse and confirmed that yes, we could contribute 100% of her salary to the 401k as long as we still properly withheld and paid the employment taxes. The agent even explained a special form I needed to file since we're in a community property state that would affect how this all works. Would never have known about that otherwise and could have caused problems later. Worth every penny just for that piece of advice alone.

Just a heads up on something that nobody's mentioned yet: make sure your spouse is doing ACTUAL work with ACTUAL market value. I went through an audit where the IRS disallowed all my spouse's salary deductions because I couldn't prove she was doing legitimate work at a fair market rate. Keep a detailed log of hours worked and tasks performed. Take pictures of work product. Save emails about business matters. Create a real job description with duties that match her skills and experience. Pay a reasonable salary for those duties - not too high, not too low. The IRS specifically looks at family employee situations because they're often abused. Don't let documentation be your downfall.

One option nobody's mentioned - have you looked into a SIMPLE IRA instead of a Solo 401k? The contribution limits are lower but the admin work is MUCH easier. My wife helps with my real estate business and we went this route because the paperwork was overwhelming with the 401k.

Don't forget about the QBI deduction implications of hiring your spouse. Putting too much into their salary could reduce your Qualified Business Income deduction if you qualify for it. You need to balance the retirement contribution benefits against potential QBI losses.

Great point about the QBI deduction! This is something I hadn't fully considered. For anyone else reading, the QBI (Section 199A) deduction can be up to 20% of your qualified business income, but it gets complicated when you have employees. When you pay W-2 wages to your spouse, those wages reduce your net business income that's eligible for QBI. However, having W-2 wages can also help you qualify for QBI if your income is in the phase-out range ($182,050-$232,050 for single filers in 2024). The key is finding the sweet spot where the tax savings from maxing out retirement contributions outweigh any reduction in your QBI deduction. This really depends on your total income level and tax bracket. I'd recommend running the numbers both ways - with and without spousal employment - to see which scenario gives you better overall tax savings. A tax software program or CPA can help model this, especially since the QBI rules are pretty complex with all the wage and income limitations.