When Should You Set Up an LLC with a Spouse?
Commonly, family businesses, even those businesses set up as a limited liability company (LLC), rely on help from a spouse and other family members. An LLC is a business type that is set up to protect members from personal liability for business debts and other legal liabilities. In some circumstances, the benefits of limited liability may diminish when a spouse regularly participates in a business because the spouse may incur personal liability for his or her actions.
Personal Liability of a Participating Spouse
If a spouse regularly works in an LLC, a spouse may incur personal liability for their actions if they fall under the following categories:
- Independent contractor: If the law considers the spouse an independent contractor, the spouse may be subject to personal liability. Determining whether the spouse is an independent contractor depends on several factors, including whether the person or company receiving the services has a right to control the result of the work and the method in which it is accomplished. Because independent contractors are not employees, they are personally liable for their acts.
- Employee: The law may hold an employer liable for the injury caused by its employees. While the members of the LLC receive protection from personal liability for the actions of employees, when the employee's acts are independent or not related to the functions of the job the employee may incur personally liability. If a spouse is considered an employee, personal liability may result if the actions were outside the scope of employment.
- General partner: Under a general partnership, partners are personally liable for the debts of the business. This means that if the law considers a spouse a general partner of the business, personal liability may attach.
The personal liability of a spouse defeats the purpose of an LLC set-up because property owned by the spouse alone and property owned jointly by the spouses may be subject to a legal judgment.
Tax Complications of a Participating Spouse
Other complications may arise when a spouse regularly works in an LLC. If a spouse receives payment for their services from the LLC, the IRS may consider the spouse an employee. Consequently, the failure to pay payroll taxes and withhold other taxes may result in IRS penalties. Having an employee also requires paying other expenses like unemployment insurance and workers' compensation insurance.
If, on the other hand, a spouse is not paid for working on an occasional basis, the IRS will probably not consider the spouse an employee.
When a Spouse Regularly Takes Part in the Business
If a spouse contributes to the business in minor ways and on an infrequent basis, in most cases this will be unproblematic. In some circumstances, it may be best to make the spouse a member of the LLC when any of the following occurs:
- The spouse receives payment for their contribution;
- The spouse regularly participates in and is involved with the business; or
- The spouse conducts business or interacts with the public on behalf of the LLC.
Make a Spouse a Member of the LLC
When a spouse frequently works in an LLC, one of the best ways to avoid personal liability is to make the spouse a member. An LLC can add new members by following the terms of the "operating agreement." The operating agreement, the document created when the LLC was set up, defines important terms about the management of the company.
In general, operating agreements require all members to agree to the addition of a new member. After the addition of a member, a limited liability company must amend the operating agreement to reflect the changes to the members' interests in voting, profits, and losses. To avoid complications with the IRS, the spouse's voting rights and the rights to profits should reflect more than a zero percent interest.
Get Legal Help Setting Up Your LLC
Before deciding to make your spouse a member of an LLC, your first step should be to consult a lawyer to understand the legal implications. An experienced small business attorney will be able to explain the tax implications and help you avoid problems before they arise. Get started today by contacting a small business attorney near you.
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