Family ties: How to hire your spouse and children legally
■ A column about keeping your practice in good health
Andrew Schwartz, a certified public accountant and a partner at Schwartz & Schwartz in Woburn, Mass., once worked with a physician who attempted to deduct from the practice's taxes the wages paid to his children. All the money for the year was given to his offspring in large checks written on Dec. 31, and the Internal Revenue Service disallowed it.
"If he had written checks regularly throughout the year for the time spent at his practice, he would have most likely been allowed the deduction," Schwartz said.
When a solo or small medical practice launches or expands, physicians commonly turn to a spouse or other relative to help run it. Sometimes the hiring is done in such an informal way that the practice runs afoul of tax regulations and creates the kind of financial headaches that a practice might have hoped to avoid by hiring a relative for the occasional contribution. For example, family members sometimes work without direct compensation, but paying a reasonable wage may save the practice money and help with retirement planning.
"Free labor is sometimes worth exactly what you pay for it" if it undermines the practice's finances, said Craig Aronoff, PhD, co-founder and principal of the Family Business Consulting Group in Marietta, Ga.
Experts say the first step to reduce the chance of financial pain when hiring a family member is to structure the position as if a nonrelative were in it. A job description should be written, and wages should be issued on a regular schedule. If staffers receive performance reviews, so should the relative.
This is particularly critical to qualify for the potential tax benefits of employing relatives. This may include shifting income from a physician to a spouse or a child. For instance, an individual can earn up to $5,800 without being subject to income tax.
"The business gets to claim a deduction for the amount paid for the wage, and it's tax-free income for the kids," Schwartz said.
This can reduce the physician's and practice's tax bills, but the pay must make sense for the job, according to IRS regulations.
"The compensation paid to that person needs to support the duties that the person is going to do. It needs to be reasonable," said Ron Finkelstein, a CPA and partner-in-charge at the Fort Lauderdale, Fla., office of Morrison, Brown, Argiz & Farra. "Before you get into an analysis of the tax savings, make sure you can justify [what you are] paying that person."
In some situations, children or a spouse may cost less to employ than others. For instance, a physician in a sole proprietorship or a partnership with a spouse can employ a child younger than 18 without paying Social Security and Medicare taxes, experts said. The federal unemployment tax does not have to be paid for people younger than 21. A physician in some form of incorporation still would have to pay these payroll taxes.
A husband-and-wife team who are physicians and run a practice equally may be considered a partnership business by the IRS if the practice is not set up as a corporation. The more common scenario involves a physician-owner with a nonphysician spouse employed in some capacity. A sole proprietor would not have to pay federal unemployment taxes for a spouse who is employed, although the other usual tax withholdings would apply. The practice and the physician still may be able to save on income taxes if paying a spouse means some of the couple's total income is taxed at a lower rate.
When deciding if adding a spouse to the payroll helps more financially than hiring someone else, "the general rule of thumb is that the income tax savings should be equal or greater than the additional employment tax that would have to be paid on behalf of the spouse," Finkelstein said.
Tax savings for hiring a spouse may come down to a coin flip, but experts say the biggest advantage to making a spouse an official, on-the-books employee -- if there is an appropriate job available -- is for retirement planning. Both spouses would be able to make deposits to their 401(k) plans and individual retirement accounts on a tax-exempt basis, doubling the upper limit for annual contributions.
Physicians who employ a spouse say other benefits should be considered. For instance, Matthew Levin, MD, a family physician in solo practice in Greensburg, Pa., employs his wife full time for bookkeeping and front desk work. The practice does not save on taxes, but it qualifies for small group health insurance coverage, which is easier to get and less expensive than family coverage. This also means she is paying into her own Social Security benefits.