If you've started a business with your spouse, you may be stumped when tax time rolls around. How are you supposed to file your business taxes?
Previously, the rules were strict: Married couples were required to file as a partnership if they hadn’t created a different business structure. But the IRS has now made things easier by creating an option to file as a qualified joint venture.
Why the IRS created the qualified joint venture
Before qualified joint ventures were allowed, married couples that jointly owned a business often opted to be treated as a partnership. This treatment meant additional paperwork and filings were required, which cost time and money.
Some couples, to avoid the additional filing work, were acting as sole proprietors and filing a Schedule C with their tax return, and only recognizing that one spouse was self-employed. That meant that only one spouse would receive credit for Medicare and Social Security contributions.
The creation of the qualified joint venture option is considered a “common-sense” change to help taxpayers accurately report business income and eliminate unnecessary paperwork. In 2002, before the qualified joint venture option was created, 2.1 million joint returns were filed with one spouse filling out a Schedule C and one spouse not reporting any income. The IRS inferred that it was likely that a number of these married couples were actually running a joint business but were choosing to have only one spouse claim the income to make filing taxes easier.
If you’re running a business with your spouse and the business isn’t structured as a partnership, LLC or corporation, there are two main benefits of filing as a qualified joint venture:
Ease of filing
When you file as a partnership, there’s a lot of additional paperwork required. Aside from the initial filing to create your partnership, there are annual documents to file during tax season. You’re required to file an information return Form 1065 as well as provide each partner with a K-1, which details their share of income from the partnership. That income is then reported on the partner’s individual tax return.
With a qualified joint venture, there’s no need to file anything additional. You don’t file the additional return or K-1 with the partnership. Each person simply fills out a Schedule C and Schedule SE, which shows how much income they received and how much they paid in taxes.
Recognition of self-employment taxes paid
If you’re earning an income through self-employment, you’re required to pay self-employment taxes on that income using Schedule SE. When only one spouse reported self-employment income to avoid the paperwork that comes with a partnership, this meant that only one spouse would get the credit for the taxes paid.
This creates a problem in retirement — your own Social Security benefits are impacted by how much and how long you paid into Social Security during your working years. If only one spouse was recognizing that they paid self-employment taxes, the other spouse was getting short-changed with respect to their future Social Security benefits.
Qualified joint venture requirements
The IRS does lay out some criteria that must be met in order to file taxes as a qualified joint venture:
The only owners of the business are a married couple that file a joint return.
Both spouses materially participate in the business.
Both spouses agree to be treated as a joint venture — and not a partnership.
If you meet those three basic criteria, you’re eligible to have your business treated as a qualified joint venture during tax time.
How do you file taxes?
One of the major benefits of a qualified joint venture is the ability to file taxes easily, by including this income on your 1040 tax return. Because the IRS treats a qualified joint venture as a sole proprietorship, each spouse will fill out a separate Schedule C, Profit or Loss from Business and Schedule SE, Self-Employment Tax. They’ll file these along with their 1040.
How much each spouse puts on their Schedule C should be reflective of their interest in the business. If a couple earns $100,000 and they each have a 50% interest in the business, each person would report $50,000 in income on Schedule C. If they earn $100,000 but have a 70/30 interest in the business, one person would report income of $70,000 while the other reports income of $30,000. Deductions on Schedule C are treated the same way — split between the two Schedule C’s, reflective of each person’s interest in the business.
One thing to note is that an employer identification number (EIN) isn’t required for a qualified joint venture. The IRS only requires that a sole proprietor use an EIN if they are required to file excise, employment, firearm, alcohol or tobacco returns.
If the business does have employees and is required to pay federal employment taxes, either spouse may report and pay the taxes due using their own sole proprietorship EIN.
A qualified joint venture is a tax designation — it allows married couples to file as sole proprietors in a jointly owned business. And being a sole proprietor comes with drawbacks.
One of the biggest drawbacks is risk and personal liability. As a sole proprietor, your business isn’t a separate legal entity. That leaves you personally liable for any debts or legal issues that arise during the course of your business.
Another drawback is that depending on how much you make, you may actually end up paying more in taxes than if you were to form another business structure, like a corporation. That’s because sole proprietors may sometimes pay more in self-employment tax, compared with owners of a corporation, who are able to be paid in a combination of salary and dividends.
Taxes are a complicated issue with businesses. The pros and cons of deciding your filing status and business structure are best to be discussed with a CPA or attorney. They can help you decide exactly what is best for your specific situation.
Can an LLC be considered a qualified joint venture?
Whether or not an LLC can be considered a qualified joint venture can be confusing because the answer varies by state.
In general, if a married couple forms an LLC in a state that is not a community property state, they won’t be able to file taxes as a qualified joint venture. If they do live in a community property state — and meet all the other criteria for a qualified joint venture — they may sometimes be considered sole proprietors for tax purposes and file a Schedule C and Schedule SE.
A version of this article was first published on Fundera, a subsidiary of NerdWallet.