Working with family and friends is difficult. Working with a spouse is even more complicated because you don't want to sacrifice your relationship to the demands of the business. But if you make some decisions and put things in writing before you begin, the chances are better for both your marriage and your business to succeed.
Before You Start Into Business With Your Spouse
Some decisions you must make:
- What business legal type will you use?
- Will both spouses be owners?
- Will both spouses participate in managing the business?
Of course, you will need to consider the tax effects of these decisions.
Who Owns the Business? Who Manages the Business?
One of the first significant decisions is whether you will both own a share in the business and participate in running the business. Some questions to ask yourselves as you consider this decision:
- Do both spouses have the business experience and expertise that is essential to owning a business?
- Do both spouses want to be decision-makers?
- Does one spouse have other outside commitments?
- Do both spouses have the ability to work in the business full-time?
- Do both spouses want to manage day-to-day business activities, like marketing, accounting, and employee management?
Your decision on who owns the business and whether both spouses will be managers determines the type of business you need.
If Both Spouses Are Owners
If you decide that both spouses are owners and will participate in running the business, your next decision is what business type you will form.
Your options are:
- Partnership, with each spouse having a partnership share.
- Limited Liability Company (LLC), with each spouse having a membership share, or
- Corporation (with the possibility of electing to be an S corporation)., and each spouse as a shareholder.
CPA Gail Rosen says husband-wife businesses make sense from several perspectives:
One of the main reasons Gail suggests both spouses have ownership is to file a separate partnership tax return. If there is only one owner, then the business files their taxes for the business as part of their individual 1040 on Schedule C. There is a significantly lower risk of an audit when a partnership return is filed, versus a Schedule C return. In 2017, the audit risk for a partnership tax return was .4% and for a Schedule C was 1.6% to 4.3% depending on the business’s gross income.
If both partners are significantly involved in the business, she says, they may feel more comfortable having an ownership piece.
if you travel for business with your spouse, for their travel to be tax-deductible, there must be a bona fide business purpose for them to attend. If they are a co-owner, it may be easier to justify the deduction.
If One Spouse Is an Employee
If one spouse is an employee, it makes the tax situation a little less complicated. The owner-spouse can set up the business as a sole proprietorship or a single-member LLC with little paperwork involved.
The employee spouse receives a paycheck, with federal income tax and FICA tax(Social Security/Medicare) withheld. The employee-spouse also receives Social Security credit based on wages.
CPA Gail Rosen also discussed a benefit of one spouse as an employee:
When you own a non-incorporated business (Schedule C or partnership), the owners need to make quarterly estimated tax payments to fulfill their tax obligations. This obligation, of putting aside money to pay quarterly taxes, can be a hardship for some individuals. I find that for these clients, if they have one spouse as an employee on payroll, and withholding is taken out automatically, it is easier for them to fulfill their tax obligations.
Taxes for Spouses in Business
If both spouses own the business, they pay taxes on the income from the business as owners:
- Partnerships, LLCs, and S corporations are pass-through businesses. Each owner's share of the business income is passed through to their personal income tax return. For example, if each spouse owns 50% of a partnership, each reports 50% of the income for the year on Form 1040.
- Spouses as owners of pass-through businesses also must pay self-employment taxes (Social Security/Medicare tax for self-employed business owners) based on their share of business income for the year.
- Spouses as owners (shareholders) of a corporation pay tax on dividends, and the corporation pays tax on its income.
If one spouse is an employee, the employee pays income taxes based on their salary.
From Gail Rosen:
There is no difference in the payroll tax your spouse pays, whether you are set up as a partnership or a single owned business. If you do pay your spouse as an employee, it is important for you to know that you don't have to pay federal and state unemployment insurance taxes on their behalf. Owners do not pay federal and state unemployment taxes on their earnings, so there is no tax difference.
A Special Tax Situation for Spouses in a Partnership - the QJV
If you and your spouse will be co-owners of your business, and your business is not a corporation, you may be able to take advantage of an IRS option called a Qualified Joint Venture (QJV). This option allows two-spouse partnerships that meet specific requirements to file their business taxes using two Schedule C forms.
The QJV option is available for partnerships but it may not be available for LLCs in some states. The IRS says, "Only businesses that are owned and operated by spouses as co-owners (and not in the name of a state law entity) qualify for the election." There are special rules for married couples in community property states. Check with your tax professional if you are considering this option.
Here's how the QJV option works: Complete a Schedule C for the business for the year. Then divide each line item between you and your spouse, based on your percentage of ownership in the company. Then complete a Schedule C for each spouse, based on that percentage, and file the two Schedule C forms instead of the partnership.
Get a Business Agreement in Writing
Finally, before you start your business, there is one more thing you must do: Create agreements between you and your spouse and put those agreements in writing.
If you decide to go into a two-person business with your spouse, you should have a partnership agreement or LLC operating agreement. If you set up the business as a corporation, you will need a shareholders' agreement.
For a shared ownership business, you should also have a separate buy-sell agreement prepared, in the event of a divorce, the death of a spouse, or if one spouse wants to leave the business. A buy-sell agreement describes "what happens if..." multiple scenarios occur.
If one spouse is an employee, create an employment agreement that describes the employee's pay and benefits and what happens if either party wants to terminate the employment relationship.
The information in this article, including CPA Gail Rosen's comments, is not intended to be tax or legal advice. Every business situation is different and tax regulations and laws change. Before you make any decisions about your business, talk to both a tax professional and attorney.