Closely held businesses can have great tax and operational benefits for taxpayers. Specifically, the owner/operator has control over the tax structure, the day to day operations, the retirement planning, and ultimately the exit strategy. But what are the tax implications of a closely held business owned jointly by a married couple?
Unincorporated Business Owned by Married Couple
Lets say a married couple start a business where they buy and resell items online. The couple doesn’t have a business plan, a company logo or any formal business registration. Instead, they use websites like Amazon and eBay to resell their items online.
They each devote a considerable amount of time and effort in this venture and make a decent profit year after year. But how does this couple report their income when it comes time to filing their tax return? Can’t they simply file a Schedule C to minimize the reporting requirement and hence minimize the accounting fees?
The correct answer is that an unincorporated business jointly owned by a married couple is generally classified as a partnership for Federal tax purposes. This means the couple will generally be required to file a partnership return and report their share of K-1 income on their individual tax return.
Additional filing requirements means more accounting fees and more stringent IRS requirements when it comes to recordkeeping and retention policies. But is there anyway out of this reporting requirement since the owners are a married couple?
Election for Married Couples Unincorporated Businesses
For tax years beginning after December 31, 2006, the Small Business and Work Opportunity Tax Act of 2007 provides that a “qualified joint venture,” whose only members are a married couple filing a joint return, can elect not to be treated as a partnership for Federal tax purposes.
But why would this matter for married couples? What reasons would a married couple have for making the election to not be treated as a partnership? The two main benefits for making the election are:
- Filing a partnership return means additional filing and record keeping requirements imposed on partnerships and their partners. Making the election reduces the cost of compliance.
- Married couples who incorrectly reported the income and loss on Schedule C in the name of one taxpayer only receives credit for social security and Medicare coverage purposes for the taxpayer listed on the Schedule C.
Making the election allows certain married co-owners to avoid filing partnership returns as long as each spouse separately reports a share of all of the businesses’ items of income, gain, loss, deduction, and credit. Under the election, both spouses will receive credit for social security and Medicare coverage purposes.
Qualification For Making the Election
A qualified joint venture is a joint venture that conducts a trade or business where:
- the only members of the joint venture are a married couple who file a joint return
- both spouses materially participate in the trade or business
- both spouses elect not to be treated as a partnership and
- the businesses are not in the name of a state law entity (including a limited partnership or limited liability company). A business owned and operated by the spouses through a Limited Liability Company does not qualify for the election.
The meaning of “material participation” is the same as under the passive activity loss rules however, although rental real estate income is generally classified as passive income, meeting the above mentioned requirement and filing as a qualified joint venture will not alter the character of passive income or loss.
How to Make the Election
To make the election the married couple will simply file jointly on their Form 1040 and split their respective share of income, gain, loss, deduction, and credit between them in accordance with each spouse’s respective interest in the joint venture.
Each spouse will report their respective share of income, gain, loss, deduction and credit on forms Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship) or Schedule F (Form 1040), Profit of Loss From Farming. The couple will also be required to file other applicable schedules such as Schedule SE (Form 1040), Self-Employment Tax.
Each spouses respective business will be treated as its own sole proprietorship and must be reported using the social security number of the respective taxpayer unless an EIN is required. An EIN is generally not required for a sole proprietorship unless the sole proprietorship is required to file excise, employment, alcohol, tobacco, or firearms returns. If an EIN is required, the filing spouse should complete a Form SS-4 and request an EIN as a sole proprietor.
What if Previous Partnership Returns Were Filed Under the Business’s EIN?
If the couple has already filed partnership returns in the past using the business’s EIN then switching to a qualified joint venture isn’t as easy as simply making the election. It gets increasingly complicated when you throw in the fact that the business has employees.
For starters, the EIN of the partnership must stay with the partnership and cannot be used as the EIN for either of the spouse’s sole proprietorship returns (i.e. on their schedule C). If the business is required to have an EIN then both spouses must apply for new and separate EINs for their respective sole proprietorship.
If the business has employees, either of the sole proprietor spouses may report and pay the employment taxes due on wages paid to the employees, using the EIN of that spouse’s sole proprietorship.
If the business already filed Forms 941 or paid taxes for part of the year under the partnership’s EIN, the spouse may be considered the “successor employer” of the employee for purposes of determining whether the wages have reached the social security and Federal unemployment wage base limits (see Publication 15 for more information).
Lastly, failure to file a partnership return going forward will most likely trigger a letter from the IRS requesting a Form 1065. If this is the case then the taxpayer can call the IRS or respond in writing to the notice stating that they reported the income on their jointly-filed individual income tax return as a qualified joint venture.
Partner With a CPA
Making the election to be treated as a qualified joint venture can have unintended consequences. Therefore, it’s important to partner with a CPA before making the election. With the passage of the Tax Cuts and Jobs Act there are several other considerations to take into account before deciding that a qualified joint venture is right for you.
This material has been provided for general informational purposes only and does not constitute either tax or legal advice. Although we go to great lengths to make sure our information is accurate and useful, we recommend you consult a tax preparer, professional tax advisor, or lawyer.