Photo by Living in Monrovia at Flickr.com
First and foremost—this post will only apply to a limited number of people, so please don’t go changing your business ownership based on the title.
One of the downsides of owning your own business is that you have to pay self employment tax. Self employment tax is 15.3% of your profit, you pay it in addition to your regular tax rate. So, if you’re in the 25% income tax bracket, you’re actually paying 40.3% in taxes on your self employment income. That’s a lot of tax.
Social security makes up 12.4% of that. (8.4% for 2011 only.) The maximum amount of your earnings that are subject to Social Security taxes is $106,800. Once you cross that threshold, you don’t pay Social Security tax anymore for the year. If you’re in that situation, you know how great it is when your company quits withholding your Social Security, it’s like a temporary pay raise.
So let’s say that you own a small business with a net profit of $50,000. Your husband gross pay is $125,000 a year. He’s already completely paid up for his Social Security. After claiming all of your deductions, let’s say your taxable income is $135,000 – that’s still in the 25% tax bracket. Your tax liability would be $33,765. That would be $26,115 for your regular tax plus another $7,650 for your self employment tax.
But what if your husband owned the business instead of you? He’s already maxed out his social security taxes. In this case, your total tax liability would be $27,565. That would be the same $26,115 for the regular tax, plus only $1450 for the self employment tax (it would be the Medicare portion.) In this example, it’s a total tax savings of over $6,000.
What are the downsides? Obviously, you wouldn’t want to have your business in your spouse’s name if divorce were a possibility. It wouldn’t make sense to do this if your spouse’s wage income wasn’t above or at least near the social security maximum threshold. Also, by putting the business in your spouse’s name, then you’re not contributing to your social security pool for the future. See that $6,000 saved in the scenario above? The best thing to do with that money is to put it towards your retirement.
Another issue is continuity. If you’ve had your business in your name for 20 years, why would you change it now? On the other hand, if you’re starting a new venture maybe it makes sense to set it up that way. You may have other perfectly legitimate reasons for not doing this as well. It’s an option for saving some money, certainly not a requirement.