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Tax Rules for a Husband and Wife Co-owned Sole Proprietorship (Qualified Joint Venture)
When two or more people own an unincorporated business, it is generally classified as a partnership. This is true even for an unincorporated business co-owned by a married couple.
However, for tax years beginning after December 31, 2006, the Small Business and Work Opportunity Tax Act of 2007 (Public Law 110-28) provides that a qualified joint venture (QJV) whose only members are a husband and wife filing a joint return, can elect not to be treated as a partnership for federal tax purposes and can be treated as a disregarded entity. In other words, the business can be treated as a sole proprietorship instead of a partnership.
This means, as a QJV, each co-owner spouse may file their own, separate, Schedule C (or Schedule F for farmers) and Schedule SE and will not be required to file Form 1065, U.S. Return of Partnership Income, or issue Schedule K-1 to each spouse, which is used to report each partner's share of income, deductions, credits, etc.
Married Co-Owners of an LLC
If a married couple own an unincorporated business as co-owners in a community property state in the name of a state law entity, such as a limited liability company, they will qualify for the qualified joint venture election. See Rev. Proc. 2002-69, 2002-2 C.B. 831, for special rules applicable to husband and wife state law entities in community property states.
Community property states include:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas
- Washington
- Wisconsin
- A tenth state, Alaska, has an "opt-in" community property law that allows such a division of property if both parties agree. Registered domestic partners who live in California, Nevada, or Washington are also subject to community property laws.
What this means is, if you and your spouse live in a community property state and are the only members of your LLC and choose to treat your business as a sole proprietorship, you and your spouse may file your own Schedule C (or Schedule F) and your own Schedule SE.
On the other hand, if a married couple own an unincorporated business as co-owners in a non-community property state in the name of a state law entity, such as a limited partnership or limited liability company, they do not qualify for the qualified joint venture election.
This means, the default tax treatment for federal tax purposes of the business will be a partnership. Form 1065 must be filed for the partnership and each co-owner spouse must be issued Schedule K-1.
IRS Definition of a Qualified Joint Venture
A qualified joint venture is a joint venture that conducts a trade or business where:
- the only members of the joint venture are a husband and wife who file a joint return
- both spouses materially participate in the trade or business, and
- both spouses elect not to be treated as a partnership.
A qualified joint venture, for purposes of this provision, includes only businesses that are owned and operated by spouses as co-owners, and not in the name of a state law entity, such as alimited partnership or limited liability company.
However, as previously mentioned, when it comes to LLCs co-owned by a married couple, if they live in a community property state and their are no other members in the LLC, and they file a joint return, they can elect to treat the entity as a disregarded entity (a sole proprietorship) for federal income tax purposes and the Internal Revenue Service will accept the position that the entity is a disregarded entity for federal tax purposes.
The spouses must share the items of income, gain, loss, deduction, and credit in accordance with each spouse's interest in the business.
Joint ownership of property that is not a trade or business does not qualify for the election.
How to Make the Election to be Treated as a Qualified Joint Venture
Spouses make the election on a jointly filed Form 1040. Each spouse divides all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s respective interest in the joint venture.
Each spouse files a separate Schedule C, Profit or Loss From Business (Sole Proprietorship) or Schedule F, Profit of Loss From Farming, Form 4835, Farm Rental Income and Expenses.
Each spouse also files a separate Schedule SE, Self-Employment Tax so that each spouse will get credit for their own social security and Medicare benefits.
How to Report Federal Income Tax as a Qualified Joint Venture (including self-employment tax)
Spouses electing qualified joint venture status are treated as sole proprietors for federal tax purposes. The spouses must share the businesses’ items of income, gain, loss, deduction, and credit in accordance with each spouse's interest in the business.
For example, if the business has $100,000 of revenue and $40,000 in expenses and each spouse has a 50% interest in the business, each spouse reports $50,000 of income and $20,000 of expenses on their own separate Schedule C (Schedule F for farmers).
Spouses with a rental real estate business not otherwise subject to self-employment tax must check the box on Line 1 of Schedule C and should not file Schedules SE.
However, if there are other net earnings from self-employment of $400 or more, the spouse(s) with the other net earnings from self-employment should file Schedule SE without including the amount of the net profit from the rental real estate business from Schedule C on line 2. If the election is made for a farm rental business that is not included in self-employment, file two Forms 4835 instead of Schedule F.
Spouses Do Not Generally Need an Employer Identification Number (EIN) for the Qualified Joint Venture
Spouses electing qualified joint venture status are treated as sole proprietors for Federal tax purposes. Using the rules for sole proprietors, an EIN is not required for a sole proprietorship unless the sole proprietorship is required to file excise, employment, alcohol, tobacco, or firearms returns.
What if Spouses Already Have an EIN for the Partnership?
One spouse cannot continue to use that EIN for the qualified joint venture. The EIN must remain with the partnership (and be used by the partnership for any year in which the requirements of a qualified joint venture are not met).
How to handle requests from the IRS for a partnership return from the spouses for tax years for which the election is in effect
Once the election is made, if the spouses receive a notice from the IRS asking for a Form 1065 for a year in which the spouses meet the requirements of a qualified joint venture, the spouses should contact the toll-free number that is shown on the notice and advise the telephone assistor that they reported the income on their jointly-filed individual income tax return as a qualified joint venture.
Alternatively, the spouses can write to the address shown on the notice and provide the same information.
How a Qualified Joint Venture Reports and Pays Federal Employment Taxes
If the qualified joint venture has employees, either of the 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 Form 941 or deposited 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 on the successor employer rules.
Duration that the Election Remains in Effect
Once the election is made, it can be revoked only with the permission of the IRS. However, the election technically remains in effect only for as long as the spouses filing as a qualified joint venture continue to meet the requirements for filing the election.
If the spouses fail to meet the qualified joint venture requirements for a year, a new election will be necessary for any future year in which the spouses meet the requirements to be treated as a qualified joint venture.