If spouses run a business together as co-owners, the business will be classified as a partnership for tax purposes unless they take steps to change the classification. Filing a tax return as a partnership can be especially complicated and onerous, so many business owners would prefer to classify their business differently. Partnership tax returns often require the assistance of tax professionals, which can be expensive.
Spouses who are filing taxes as owners of a partnership must complete Form 1065 to report the income, deductions, gains, and losses of the partnership. In addition, they must complete a Schedule K-1 for each spouse, which will document the spouse’s share of the income or losses of the partnership. Then, they will need to copy this information onto a Schedule E for each spouse and complete a Schedule SE for each of them. This will list their share of the partnership income as self-employment income. Finally, they must copy the information from the schedules onto the Form 1040 that the spouses are filing jointly.
Avoiding Filing as a Partnership
Instead of filing partnership tax returns, spouses who run a business together often prefer to treat the business as a sole proprietorship run by one of them. This means that they would need to file only one Schedule C and one Schedule SE, which would be filed in the name of just one spouse. Only that spouse will pay taxes for Social Security and Medicare.
While this is more efficient, the spouses could suffer losses if the IRS or the Social Security Administration investigates their situation further. If either agency decides that the business is actually a partnership run by both spouses, it could reallocate their business income and require the spouses to pay extra Social Security taxes. The spouse who did not appear on Schedule C would not have their business expenses covered because they were not listed as an employee or owner of the business.
Forming a Joint Venture
Instead of trying to treat your business as a sole proprietorship, you should consider classifying the business as a qualified joint venture. This means that the spouses are the only owners of the business, and they materially participate in it. In other words, they are consistently involved in the operations of the business and have a significant impact on them. If a spouse devotes more than 500 hours in a year to working for the business, the business should qualify as a joint venture for tax purposes. As a result, each spouse would be officially considered a sole proprietor.
You would need to file Form 1040 jointly to qualify your business as a joint venture. In addition, your spouse and you would need to file separate Schedule C and Schedule SE forms to cover your share of the profits and losses of the business, as well as self-employment taxes. This will allow your spouse and you to both get Social Security and Medicare coverage. In most situations, the spouses own the business equally, which means that they would equally share the profits, losses, deductions, and credits related to the business. Either spouse can cover the employment taxes related to any employees of the business.