Do you get a payroll tax holiday and retention credit for hiring your spouse?

Practice Alert

The Hiring Incentives to Restore Employment Act (HIRE Act, P.L. 111-147) carried two valuable incentives for employers that boost payroll this year:

· a payroll tax holiday for employers that hire unemployed workers;

· and an up-to-$1,000 tax credit for keeping such new hires on the payroll for at least one year.

Practitioners have raised the question as to whether these tax breaks apply if a business person hires his or her formerly unemployed spouse. As this Practice Alert explains, the answer in many instances will be “yes.”

Background. Under Code Sec. 3111(d), as amended by HIRE Act Sec. 101(a), qualified employers are exempted from paying the employer 6.2% share of Social Security (i.e., OASDI) employment taxes on wages paid in 2010 to a newly hired qualified individual. This is an individual who:

1. begins employment with the employer after Feb. 3, 2010 and before Jan. 1, 2011;

2. certifies by signed affidavit, under penalties of perjury, that he or she hasn't been employed for more than 40 hours during the 60-day period ending on the date employment begins with the qualified employer;

3. does not replace another employee of the employer (unless that other employee left voluntarily or for cause); and

4. is not related to the qualified employer in a way that would disqualify the individual for the work opportunity tax credit (WOTC) under Code Sec. 51(i)(1). (Code Sec. 3111(d)(3))

The payroll tax relief applies only for wages paid with respect to employment beginning on Mar. 19, 2010 (the day after the HIRE Act was signed into law by the President) and ending on Dec. 31, 2010. The payroll tax holiday doesn't apply for wages paid during the first calendar quarter of 2010. Instead, the amount by which the qualified employer's OASDI tax for wages paid during the first calendar quarter of 2010 would have been reduced if the payroll tax holiday had been in effect for the first quarter is treated as a payment against the employer's OASDI tax for the second calendar quarter of 2010.

A qualified employer is any employer other than the U.S., a state, or a political subdivision of a state (i.e., a local government, or an instrumentality). (Code Sec. 3111(d)(2)(A)) However, a public institution of higher education is a qualified employer even though it is a government instrumentality. (Code Sec. 3111(d)(2)(B)) A qualified employer may elect, in the manner that IRS requires, not to have the payroll tax holiday apply. (Code Sec. 3111(d)(4)) Unless the employer elects out of the payroll holiday, wages paid or incurred to a qualified individual won't qualify for the WOTC during the one-year period beginning on the date that the qualified employer hired the individual. (Code Sec. 51(c)(5))

Popping the question. Does the payroll tax holiday apply if the taxpayer (e.g., a sole proprietor or someone operating a business as a corporation) hires a spouse as a bona fide employee? Although it's not clear that Congress intended this result, the answer is “yes,” assuming the conditions highlighted above are met.

Reasoning. Under condition (4), above, an individual cannot be an “individual described in Code Sec. 51(i)(1) (applied by substituting 'qualified employer' for 'taxpayer' each place it appears.” The fact is that while Code Sec. 51(i)(1) casts a very wide net in preventing related parties from qualifying, it does not include a spouse within its rule.

The portions of Code Sec. 51(i)(1) that are most likely to be relevant (i.e., situations other than those dealing with estates and trusts) are as follows (applied by substituting 'qualified employer' for 'taxpayer'):

· Under Code Sec. 51(i)(1)(A), an individual can't bear any of the relationships described in Code Sec. 152(d)(2)(A) through Code Sec. 152(d)(2)(G) to (1) the qualified employer, or, (2) if the qualified employer is a corporation, to an individual who owns, directly or indirectly, more than 50% in value of the outstanding stock of the corporation, or, (3) if the qualified employer is an entity other than a corporation, to any individual who owns, directly or indirectly, more than 50% of the capital and profits interests in the entity, (determined with the application of Code Sec. 267(c)).

· Under Code Sec. 51(i)(1)(C), an individual can't be a dependent (described in Code Sec. 152(d)(2)(H)) of the qualified employer, or, if the qualified employer is a corporation, of an individual described in Code Sec. 51(i)(1)(A).

Code Sec. 152(d)(2)(A) through Code Sec. 152(d)(2)(G) enumerate the taxpayer's children or their descendants, siblings or step-siblings, parents or a parent's ancestor, step-parents, nephews, nieces, uncles, or aunts, and in-laws. They don't mention a spouse. Also a person's spouse isn't his or her dependent, so Code Sec. 51(i)(1)(C) doesn't apply. So there's no rule in the Code barring the payroll tax holiday from being claimed for a person just because he or she is a spouse.

This conclusion is bolstered by IRS's recently issued Form W-11, Hiring Incentives to Restore Employment (HIRE) Act Employee Affidavit, which newly hired, but formerly unemployed, workers must sign (or its equivalent) in order for their new employers to treat the workers as qualified individuals (see Federal Taxes Weekly Alert 04/15/2010). The brief instructions to the Form essentially restate the Code Sec. 51(i)(1) restrictions and don't mention spouses. If IRS thought spouses shouldn't qualify for the payroll tax holiday, presumably it would have said so.

Retention credit applies, too. HIRE Act Sec. 103 also provides employers with an up-to-$1,000 tax credit for retaining qualified individuals, as defined for payroll tax holiday purposes. The workers must be employed by the employer for a period of not less than 52 consecutive weeks, and their wages for such employment during the last 26 weeks of the period must equal at least 80% of the wages for the first 26 weeks of the period. If a spouse is a qualified individual under the payroll tax holiday rules, and works for the requisite period of time, then the retention credit also should apply to him or her.

RIA caution: Depending on family relationships, there may be situations where a spouse will not qualify for either HIRE Act tax break. For example, if Dad owns 60% of a corporation, and Son who runs the company owns the 40% balance, then the corporation can't claim the payroll tax holiday or the retention credit if it hires Son's wife. In this situation, the wife is treated as “related” to a more than 50% owner of the qualified employer and therefore is ineligible under (Code Sec. 3111(d)(3)(D) and Code Sec. 51(i)(1)(A).

Source: Federal Tax Updates on Checkpoint Newsstand tab 5/3/2010