In this situation, the business income should be reported on a partnership income tax return (Form 1065). Although the payroll tax withholding and filing requirements do not apply to partnership earnings, the reporting of partnership income can be somewhat complicated and the services of a tax professional would likely be required. Thus, the couple would incur additional tax preparation fees.
Qualified Joint Venture.
Fortunately, if certain qualifications are met, tax law allows a married couple to avoid the payroll tax requirements of being taxed as an employer-employee and the complications of being taxed as a partnership. A married couple will be taxed as a “qualified joint venture” if the only members of the joint venture are a husband and wife, both spouses materially participate in the business, and both spouses elect to be taxed as a qualified joint venture.
A spouse is considered to “materially participate” in the venture if the spouse satisfies any of the following tests:
the spouse participated in the business for more than 500 hours during the tax year,
the spouse participated in the business for more than 100 hours during the tax year and participated at least as much as any other individual, including individuals who did not own an interest in the activity, for the year,
the spouse materially participated in the activity for any five of the ten immediately preceding tax years, or
based on all the facts and circumstances, the spouse participated in the activity on a regular, continuous, and substantial basis during the year. For purposes of this rule, a spouse will not be considered to materially participate in the business if the spouse participated for 100 hours or fewer during the year. The time a spouse spends managing the business does not count in determining whether the spouse materially participated if another person was paid to manage the business or a third party spent more hours during the year managing the business than the spouse did, regardless of whether the third party was compensated for the management services.
Making the election to be taxed as a qualified joint venture is easy. All the couple has to do is file two Schedule C’s, one for each spouse. All income, gains, losses, deductions, and credits are divided between the spouses according to their respective interests in the business. Thus, each spouse is treated as a separate sole proprietor for tax purposes.
The good news is that filing as a qualified joint venture allows each spouse to receive credit towards Social Security earnings on which retirement benefits are based. In addition, filing as a qualified joint venture generally does not increase the total tax due on the federal income tax return unless the overall net earnings exceed the annual per-person wage base limit for Social Security taxes ($113,700 for 2013).
To illustrate, let’s assume a writing business earned $150,000 in net profits in 2013. If the profits were allocated entirely to the writer, only the first $113,700 of the individual author’s earnings would be subject to the 12.4% OASDI portion of Social Security, for a total OASDI tax of $14,098.80 ($113,700 x .124). However, if the profits were allocated equally between the writer and the spouse so that each reported $75,000 in net earnings, each spouse would pay OASDI tax of $9,300 ($75,000 x .124 x 2), for a total OASDI tax of $18,600. As a final example, let’s assume that the author reports 90% of the net earnings ($135,000) and the spouse reports the remaining 10% ($15,000). The total Social Security taxes paid by the couple would be $15,958.80 ($14,098.80 assessed on the author’s first $113,700 of net profits plus $1,860 assessed on the spouse’s net profits).
On the other hand, if we assume the net profits of the writing business were less than the annual perperson wage base limit, say $100,000, the total OASDI would be the same regardless of how the net earnings are allocated between the spouses. The full $100,000 would be subject to the 12.4% OASDI tax since it is less than the annual wage base limit.
Things to Consider.
In my tax practice, I encountered several clients who had worked in their spouse’s Continued on page 20