California is a community property state, so unless you use pre-marriage assets to fund the business, your spouse is automatically a co-owner - whether they work in the business or not. This means that they are equally liable for any losses and will equally benefit from any gain.

If your spouse is directly involved in the business, you can treat (him)/her as an employee or as a partner. The advantage of staying a sole proprietor and treating your spouse as an employee is that you can deduct health insurance premiums for your entire family as a business expense. The downside of this is that you have to do payroll paperwork for income paid to your spouse and you must provide the same health insurance benefits to your other employees so your benefits aren't "top heavy". For more information about Section 105 tax deductions for health expenses, click here.

Alternatively, you can treat your spouse as a partner, eliminating payroll paperwork, but still give your spouse separate payments to social security. You will not be able to deduct health insurance premiums for any partner.

Finally, some businesses stay as sole proprietors with no compensation paid to the spouse. The IRS doesn't really care as long as your business' profit before paying the owners is less than $106,800. If it is more, you need to treat your working spouse as an employee or a partner so that enough social security self-employment tax is paid. With this option, you will not be able to deduct health insurance premiums for you or your spouse as a business expense.

Limited liability protection will not protect you from actions that you took yourself or from tax obligations. You can purchase insurance for your actions (professional liability, errors and omissions).