Spouse As Single Member
If you operate your business as a single-member LLC, the Internal Revenue Service will tax your business income as if you were a sole proprietor. Sole proprietors report net profit from an LLC on a Schedule C attachment filed with their personal tax returns. When filing a joint return, the net profit is combined with all other income that you and your spouse earn, and income tax is calculated on the total. Since your spouse would report any wages earned as an LLC employee on your joint Form 1040 anyway, the end result is approximately same. The only difference is how you categorize the income.
Joint Return Illustration
To understand how this works, suppose your LLC earns a net profit of $200,000. Assuming that this is the only source of earnings for you and your spouse, the total income reported on your joint return will be $200,000, which is reported on the “Business Income” line of your Form 1040. Now suppose you pay your spouse a $20,000 salary. Since reasonable salaries are deductible to your business, it brings your net profit down to $180,000. However, despite reducing the amount reported on the “Business Income” line of your return, your spouse needs to report $20,000 of wages. Therefore, the total income remains at $200,000.
Self-Employment Tax Advantage
As a couple, you can save money on the Social Security portion of your self-employment tax by not paying the non-member spouse for her services as an employee or independent contractor. As the LLC member, you must pay self-employment taxes on your net profit – but employees and independent contractors pay these taxes on their earnings, too. Since there's a maximum amount of income (per spouse) that is subject to the Social Security tax, the spouse who works for free will not be subject to the tax at all.
Social Security Tax Example
When you file your joint return and report $200,000 of net profit on Schedule C, you’ll need to prepare a Schedule SE and calculate your self-employment tax. Although the rates and income limitations may change each year, assume the maximum income subject to Social Security tax is $110,100 and the rate is 12.4 percent. This means that the Social Security tax bill for the member-spouse is $13,652. Now if the non-member spouse takes a salary of $20,000, Social Security taxes must be paid on this amount. Notice, however, that the member-spouse’s Social Security tax bill remains unchanged despite a $20,000 reduction in net profit because of the salary deduction. As the non-member spouse’s employer, you can deduct the portion of these taxes that you have to pay, but at the end of the day, there’s still a significant increase in the net amount of Social Security tax paid by the couple.