If you started a small business with your spouse, the federal tax implications of your decision aren’t as simple as you may think. Here’s what you need to know to report your incomes correctly to the IRS next year.
Employee or Partner?
The IRS wants to know whether your spouse is a partner or an employee. If one spouse makes all of the management decisions and the other works as a regular employee, the latter is, under IRS rules, an employee who’s subject to income-tax and FICA withholdings (but not unemployment tax).
If you and your spouse both contribute capital and participate equally in the company and management decisions, the business is a partnership. In that case, you may need to file IRS Form 1065 [PDF].
Typically, one spouse claims all of the business’s income and expenses on a Schedule C [PDF], for couples filing a joint return. For married couples filing separately, seek the advice of a tax attorney. Because the Schedule C form only allows for one Social Security number, only the taxpayer listed on the Schedule C receives Social Security and Medicare credits.
Qualified Joint Venture
If you’d like to share these credits, the IRS created the “qualified joint venture” election in 2007. This allows the husband and wife to be treated as two sole proprietors of the same business (instead of as partners). To do this, you must file jointly.
According to the IRS, your business qualifies if:
- You and your spouse are the only partners in the business;
- Both partners “materially participate” in the business;
- You file a joint tax return; and
- Both spouses agree to the election of qualified joint venture.
As a qualified joint venture, each partner completes a separate Schedule C on which they list their share of all revenues and expenses. Let’s say the partnership is 50/50 and the business had revenue of $100,000 and expenses of $60,000. Each partner would report income of $50,000 and expenses of $30,000 on their Schedule C and pay the corresponding taxes.
The partners each file a Schedule C along with the joint 1040 form.
“State Entity” Exclusion
If your business is a state entity, most commonly an LLC, you may not file as a qualified joint venture. However, spouses doing business in a community-property state — Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin — are exempt from this rule.
The qualified joint venture’s chief advantage is allowing each partner to pay into Medicare and Social Security. When a business is split between two sole proprietors, the tax burden is simply divided based on each person’s share of the business.
Whether you should remain a partnership or choose the qualified joint venture election should be discussed with a professional who’s familiar with your financial situation.
“My recommendation to every business owner is to first get a good lawyer to help incorporate your business correctly, while also speaking with an accountant about what your tax structure should be,” says Maisie Knowles, chief operating officer of Kinoli, a company she owns with her husband.
“Once that’s in place,” she adds, “speak with a financial adviser about contributing to tax-advantaged retirement accounts. Also, get an HSA health insurance plan and fund your HSA account for a tax deduction.”