Hiring Your Spouse (Section 105 Plan)

How it works

There are two separate plays here, and they usually run together, but they solve different problems and are worth seeing apart.

The first is simple: put your spouse on the payroll as a genuine employee. Wages paid for real work are deductible to the business under Section 162(a), the same as wages paid to anyone else. What makes it worth a page of its own is what the wages unlock rather than what they deduct: your spouse earns Social Security and Medicare credit in their own name, becomes eligible to defer into a solo 401(k) as a participant-employee rather than merely a spouse, and can fund a health savings account through the family's high-deductible health plan.

The second play carries the real weight. If you run a Schedule C, E, or F business, or a single-member LLC that files the same way, you cannot pay yourself tax-free medical reimbursements. Section 105(g) treats a self-employed owner as something other than an "employee" for purposes of the Section 105 exclusion, so there is no direct route to reimburse your own medical costs and keep them both deductible and tax-free. The fix is structural rather than clever: your spouse becomes the business's one and only employee, the business adopts a written Section 105 medical reimbursement plan, sometimes called a one-person HRA, and the business reimburses the employee-spouse for the family's medical expenses. Section 105(b) excludes reimbursements paid to an employee's spouse and dependents from that employee's income, and you are the employee's spouse. The family's medical bills flow through your spouse's W-2 status and land on the business's return under Section 162(a), tax-free to your spouse under Section 105(b). The case that sets the test for this structure is Shellito v. Commissioner, 437 F. App'x 665 (10th Cir. 2011), which held the question turns on ordinary common-law agency principles. It vacated and remanded rather than approving the arrangement outright, and it is not binding precedent.

This beats the more familiar alternative for a specific reason. The self-employed health insurance deduction under Section 162(l) only reaches premiums, is claimed as an above-the-line adjustment rather than a business expense, and does not reduce self-employment tax at all. A Section 105 plan reaches every dollar of Section 213(d) medical spending, not just premiums: deductibles, copays, dental, vision, orthodontia, whatever the family actually pays out of pocket. Because it is deducted on Schedule C, E, or F rather than taken as a personal adjustment, it reduces both income tax and the 15.3 percent self-employment tax on the same dollars.

What this is worth in Florida

Florida has no individual income tax and does not tax pass-through business income at the owner level, so nothing about the personal side of this changes here. The value is entirely federal, and it comes from the deduction landing on the business's return. That deduction reduces income tax and self-employment tax the same way in Florida as anywhere else; what Florida adds is that there is no state income tax sitting on top to compound the benefit, and no state add-back to worry about either. If someone tells you this is worth more because you live in Florida, they are describing a benefit that does not exist. The benefit is federal, full stop.

Who this applies to

This is built for an owner who is the sole proprietor of the business, not a co-owner alongside their spouse.

• The business. A Schedule C business, a Schedule E rental activity, a Schedule F farm, or a disregarded single-member LLC all work, because each has exactly one owner for tax purposes, and the spouse can be that owner's employee.
• The employee-spouse. Has to be a genuine common-law employee: real, substantial work, and subject to the owner's direction, not a title with no duties behind it.
• Who this does not work for. If both spouses are partners in the same partnership or members of the same multi-member LLC, neither one is an "employee" of the business for Section 105 purposes, and the conduit collapses before it starts. One spouse has to be the owner. The other has to be hired help, on paper and in fact.

The wage-only benefits, Social Security credits, solo 401(k) eligibility, and HSA access, do not depend on the Section 105 plan at all. A business that cannot use the conduit for this reason can still put a spouse on payroll for those three benefits alone; only the medical-reimbursement layer is lost.

What it requires

A handful of conditions have to hold together, and they interact with each other rather than standing alone.

• A bona fide employment relationship. Real duties, real hours, and direction from the owner, tested under the common-law employee standard. Everything else here depends on this being true, and no bona fide employment relationship means total disallowance, which is the leading way this arrangement fails.
• Reasonable compensation. Wages, and the value of any benefits provided, have to be defensible for the work actually performed. Section 162(a) only deducts what is ordinary and necessary, so pay set well above what the role is worth invites a challenge. I cover the reasonable-compensation question from the other side, an S corporation owner's own salary, in my reasonable-salary guide.
• Full FICA on every dollar. Section 3121(b)(3)(A) exempts a child under 18 employed by a parent, but only where the employer is unincorporated, so it is gone the moment the business is an S corp or a C corp. Section 3121(b)(3)(B) separately exempts a spouse's domestic service outside the employer's trade or business, meaning household help, not this. Real business work is fully subject to Social Security and Medicare tax on both sides, the same 6.2 percent and 1.45 percent that apply to any other employee. Setting payroll up correctly the first time is its own project, covered in my first-employee payroll guide.
• One employee, no more, if you want the ACA exemption. A stand-alone medical reimbursement plan would normally run into the Affordable Care Act's market-reform rules, but Section 9831(a)(2) exempts a group health plan with fewer than two participants who are current employees, and a spouse-only plan is exactly that. The plan is also free of the dollar ceiling that binds a qualified small employer HRA, because it is not one; that ceiling only applies to a workforce of more than one employee. Both advantages depend on staying at exactly one employee.

The solo 401(k) and HSA benefits layer on top once the employment itself is real. Your spouse can defer part of their own wages into a one-participant 401(k), subject to the same elective-deferral limit that applies to any 401(k) participant, adjusted for inflation every year. The business can add a profit-sharing contribution on top of that, up to 25 percent of your spouse's W-2 wages, with the combined total capped by one overall annual-additions ceiling that is also adjusted every year. I cover the full mechanics in my solo 401(k) guide. Separately, a qualifying high-deductible family health plan lets your spouse's W-2 status open the door to funding a health savings account, with its own annually adjusted ceiling and its own coordination rule: dollars reimbursed through the Section 105 plan cannot also be paid from the HSA, and a general-purpose Section 105 plan disqualifies you from HSA eligibility unless it is written as limited-purpose or post-deductible instead. Stacked together, the wage, the retirement plan, and the health benefits turn one employee relationship into several distinct tax benefits at once, which is its own kind of benefit stacking.

What you need to document

Every failure mode described below traces back to a document that either existed or did not. Build the file as you go, not at filing time.

A real job description and a real record of hours

What your spouse actually does, and evidence they actually did it. This is what the common-law employment test gets checked against.

Something independent showing the pay is reasonable

What an unrelated business would pay someone doing the same work. A number you picked yourself carries little weight next to one anchored to something outside the transaction.

Payroll run the way payroll is supposed to run

A W-4 on file, income tax and FICA withheld from every check, wages paid into your spouse's own account rather than a shared one, a W-2 issued, and the quarterly and annual payroll returns filed.

The written Section 105 plan document, dated before any reimbursement

The plan has to exist on paper before the first dollar moves. A reimbursement paid before the plan was adopted is not a reimbursement under a plan at all.

Receipts, an expense log, and proof the money actually moved

Bank records showing a transfer from the business to your spouse's own account, matched against receipts for actual Section 213(d) medical spending. This is the piece that turns a paper structure into a real one.

Where it goes wrong

None of the individual pieces here are aggressive positions. Wages for real work, a written medical reimbursement plan, a retirement account funded by actual earnings: all mainstream. What fails, almost every time, is the facts underneath the paperwork rather than the law itself.

What happened in Shellito

Shellito v. Commissioner is the case that defines this strategy's edges, and both halves of it matter. The Tax Court first denied the deductions, partly because the reimbursements moved through an account the couple held jointly rather than one belonging to the employee-spouse alone. The Tenth Circuit vacated and remanded, and it did disagree with that reasoning: it said flatly that disqualifying amounts merely because they came from a joint checking account is flawed, and noted that none of the decided cases had treated a joint account as a disqualifying factor. Its independent ground was that the Tax Court had failed to apply ordinary common-law agency principles to decide whether a genuine employment relationship existed at all. The court did not itself allow the deductions; it sent the question back, and its order is expressly not binding precedent. The lesson is about the employment question, which is what the case actually turns on. Keeping the money in a separate account is still worth doing, but as clean practice rather than as a rule this case laid down.

The recurring mistakes

• No real employment behind the title. No timesheets, no defined duties, pay that does not match the work. This is the failure mode Shellito exists to warn about.
• Reimbursements moving inside a joint account. The Tax Court leaned on this in Shellito and the Tenth Circuit rejected it as a disqualifier, so it is not a rule. It is still the cleaner practice, and it removes an argument: pay from the business to your spouse's own account, not a shared one.
• Both spouses as co-owners. If you are both partners or members of the same entity, neither of you is an "employee" under Section 105(g), and the conduit fails no matter how well everything else is documented.
• Adding a second employee without re-checking the plan. Hiring any non-spouse employee ends the one-employee exemption from the ACA's market-reform rules. Left unconverted to a compliant structure, such as a qualified small employer HRA or an individual coverage HRA, the exposure is an excise tax of $100 per day, per employee, under Section 4980D. Re-test the plan the moment headcount changes, not at tax time.
• Compensation and benefits that outrun the role. A part-time bookkeeping job paired with a large medical reimbursement invites a reasonableness challenge under Section 162(a), regardless of how clean the paperwork otherwise is.
• Reimbursing before the plan exists, or without the receipts to back it up. No written plan, no substantiation, no Section 213(d) nexus to an actual medical expense: any one of these alone can support a full disallowance.
• Double-dipping between the HSA and the Section 105 plan. The same medical expense cannot be reimbursed through the plan and paid from the HSA too. Running both at once generally means the Section 105 plan has to be written as limited-purpose or post-deductible, not general-purpose.
• Assuming the child-employment FICA break applies here. It does not. The exemption for a minor child working in an unincorporated parent's business has no counterpart for a spouse doing trade-or-business work, and treating spouse wages as exempt is a payroll tax problem waiting to surface.

A situation where this comes up

The version I see most often is straightforward: a spouse already doing real, useful work for the business, informally or without proper payroll behind it. Formalizing that relationship, running real payroll, and layering a Section 105 plan on top does not change how the business operates day to day. What changes is the paperwork: a real job description, a pay rate anchored to something other than convenience, a plan document, and receipts that get saved rather than thrown away.

The version that worries me is the one where the role gets invented to reach the deduction: a spouse added to payroll mainly on paper, a title with little behind it, sized to whatever medical reimbursement the owner wants to run that year. The deduction came first, and the employment relationship was built to justify it after the fact. That is the exact pattern Shellito punishes, and no amount of paperwork fixes it once the underlying relationship was never real.