When Your Spouse Helps Out With Your LLC

Be careful to avoid problems with legal and tax liability.

When you start a business on your own, you have a choice of ways to set it up: It can be a sole proprietorship, a corporation, or a single-member LLC. Regardless of your choice of business structure, you can run into liability and tax headaches if your spouse helps out regularly.

As a practical matter, spouses often help a small business without getting into any legal hot water, as long as they pitch in informally, infrequently, and without being paid. However, you really should decide on a business arrangement that formally acknowledges your spouse’s role if any of the following are true:

• Your spouse is being paid.
• Your spouse helps out regularly.
• Your spouse is very much involved with your LLC.
• Your spouse interacts with the public or your business contacts.

A Participating Spouse Might Have Personal Liability

Probably one of the main reasons you chose an LLC as your structure to do business was to protect your personal property from liability for business debts. This is a major advantage of the LLC business structure over the sole proprietorship.But if your spouse is involved in your business, it’s possible that your spouse could become personally liable for judgments against the business and not get this benefit of the LLC business structure. We explain why below.

There are several ways to view your spouse’s position, and each has specific liability consequences for both you and your spouse:

• Agent. Your spouse could be viewed as an agent of the LLC. Although the LLC is responsible for its agent’s authorized acts, the LLC structure usually protects your personal property from claims related to an agent's acts. The agent (your spouse) would not normally be personally liable for acts done within the scope of his or her authority to act for the company.
• Employee. Your spouse could be viewed as an employee of the LLC. An employee is personally liable only for certain extreme and unauthorized acts, such as assault or other criminal behavior. The LLC would normally protect your personal property from liability for the acts of an employee.
• An independent contractor. Your spouse could be viewed as acting as an independent contractor. An independent contractor could be held personally liable for just about anything he or she does. That means that although the LLC protects your personal property from your own liability, it would not protect your personal marital property from your spouse’s individual liability.
• A general partner. Your spouse could be treated as an individual who has gone into a general partnership with the LLC. As a general partner, your spouse would have personal liability for business debts.

Any scenario in which your spouse has personal liability is a bad scenario, because a successful claimant might try to collect a judgment from your spouse’s personal property -- which will usually include your jointly owned personal property, such as bank accounts and your house.

One way to avoid these possibly negative characterizations is to make your spouse an LLC member (co-owner). An LLC member can pitch in as much or as little as the members agree, and the LLC protects each member’s personal property from business liability. See "How a Spouse Becomes an LLC Member," below.

A Participating Spouse Could Have Tax Liability

In general, when an LLC hires either an employee or an independent contractor, it creates a “paper trail” of the LLC hiring decision. Odds are, you haven’t got this “paper trail” when your spouse pitches in. If your spouse works frequently and regularly for the LLC, but you don’t have paperwork showing an independent contractor agreement, the IRS might decide that your spouse is an employee. This could be bad, because the IRS will sock you for back withholding taxes, employment taxes, and penalties. In addition, there could be criminal liability for failure to comply with state and federal employment laws.

You can make your spouse an employee from the get-go, but if your spouse would be your only employee, it may not be worth the paperwork and record-keeping hassles. For any employee, the LLC must withhold taxes, report state and federal income tax, report and pay employment taxes, pay workers’ compensation insurance, comply with workplace-safety reports, and (in some states) pay unemployment insurance. One way to avoid some of this record keeping is for your spouse to formally become an LLC member (co-owner).

However, it’s not much better if the IRS decides your spouse was only an independent contractor -- who should have paid self-employment taxes. The IRS could assess your spouse for back self-employment taxes, interest, and penalties. So again, if your spouse spends many hours working for your business, it may make sense for your spouse to formally become an LLC member (co-owner).