Married Couples Business – What is a Qualified Joint Venture?

Married Couples Business

• The employment tax requirements for family employees may vary from those that apply to other employees. On this page we point out some issues to consider when operating a married couple’s business.

One of the advantages of operating your own business is hiring family members. However, the employment tax requirements for family employees may vary from those that apply to other employees. Below, we point out some issues to consider when operating a business as a married couple.

How spouses earn Social Security benefits

A spouse is considered an employee if there is an employer/employee type of relationship, i.e., the first spouse substantially controls the business in terms of management decisions and the second spouse is under the direction and control of the first spouse. If such a relationship exists, then the second spouse is an employee subject to income tax and FICA (Social Security and Medicare) withholding. However, if the second spouse has an equal say in the affairs of the business, provides substantially equal services to the business, and contributes capital to the business, then a partnership type of relationship exists and the business’s income should be reported on Form 1065, U.S. Return of Partnership Income (PDF).

Both spouses carrying on the trade or business

On May 25, 2007 the Small Business and Work Opportunity Tax Act of 2007 was signed into law and affect changes to the treatment of qualified joint ventures of married couples not treated as partnerships. The provision is effective for taxable years beginning after December 31, 2006.

The provision generally permits a qualified joint venture whose only members are a married couple filing a joint return not to be treated as a partnership for Federal tax purposes. A qualified joint venture is a joint venture involving the conduct of a trade or business, if (1) the only members of the joint venture are a married couple who file a joint tax return, (2) both spouses materially participate in the trade or business, (3) both spouses elect to have the provision apply, and the business is co-owned by both spouses and (4) isn’t held in the name of a state law entity such as a partnership or limited liability company (LLC).

Under the provision, a qualified joint venture conducted by a married couple who file a joint return is not treated as a partnership for Federal tax purposes. All items of income, gain, loss, deduction and credit are divided between the spouses in accordance with their respective interests in the venture. Each spouse takes into account his or her respective share of these items as a sole proprietor. Thus, it is anticipated that each spouse would account for his or her respective share on the appropriate form, such as Schedule C.  For purposes of determining net earnings from self-employment, each spouse’s share of income or loss from a qualified joint venture is taken into account just as it is for Federal income tax purposes under the provision (i.e., in accordance with their respective interests in the venture).

This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the social security tax limitation. Refer to Publication 334, Tax Guide for Small Business, for further information about self-employment taxes. For more information on qualified joint ventures, refer to Election for Married Couples Unincorporated Businesses.

One spouse employed by another

If your spouse is your employee, not your partner, you must pay Social Security and Medicare taxes for him or her. The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and Social Security and Medicare taxes, but not to FUTA tax. For more information, refer to Publication 15, Circular E, Employer Tax Guide.

Election for Married Couples Unincorporated Businesses

• 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,” whose only members are a married couple filing a joint return, can elect not to be treated as a partnership for Federal tax purposes.

An unincorporated business jointly owned by a married couple is generally classified as a partnership for Federal tax purposes. 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,” whose only members are a married couple filing a joint return, can elect not to be treated as a partnership for Federal tax purposes.

Reasons Why a Married Couple Might Want to Make the Election Not to be Treated as a Partnership

Because a business jointly owned and operated by a married couple is generally treated as a partnership for Federal tax purposes, the spouses must comply with filing and record keeping requirements imposed on partnerships and their partners. Married co-owners failing to file properly as a partnership may have been reporting on a Schedule C in the name of one spouse, so that only one spouse received credit for social security and Medicare coverage purposes. The election permits certain married co-owners to avoid filing partnership returns, provided that each spouse separately reports a share of all of the businesses’ items of income, gain, loss, deduction, and credit. Under the election, both spouses will receive credit for social security and Medicare coverage purposes.

Definition of a Qualified Joint Venture

A qualified joint venture is a joint venture that conducts a trade or business where (1) the only members of the joint venture are a married couple who file a joint return, (2) both spouses materially participate in the trade or business, and (3) 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 (including a limited partnership or limited liability company) (See below). Note also that mere joint ownership of property that is not a trade or business does not qualify for the election. The spouses must share the items of income, gain, loss, deduction, and credit in accordance with each spouse’s interest in the business. The meaning of “material participation” is the same as under the passive activity loss rules in section 469(h) and the corresponding regulations (see Publication 925, Passive Activity and At-Risk Rules). Note that, except as provided in section 469(c)(7), rental real estate income or loss generally is passive under section 469, even if the material participation rules are satisfied, and filing as a qualified joint venture will not alter the character of passive income or loss.

How to Make the Election to be Treated as a Qualified Joint Venture

Spouses make the election on a jointly filed Form 1040 or 1040-SR by dividing all items of income, gain, loss, deduction, and credit between them in accordance with each spouse’s respective interest in the joint venture, and each spouse filing with the Form 1040 or 1040-SR a separate Schedule C (Form 1040 or 1040-SR), Profit or Loss From Business (Sole Proprietorship) or Schedule F (Form 1040 or 1040-SR), Profit of Loss From Farming and, if otherwise required, a separate Schedule SE (Form 1040 or 1040-SR), Self-Employment Tax. For example, to make the election for 2014, jointly file your 2014 Form 1040 or 1040-SR, with the required schedules (see below). The partnership terminates at the end of the taxable year immediately preceding the year the election takes effect. For information on how to report the business for the taxable year before the election is made, see Publication 541 on Partnerships and terminations.

A Business Owned and Operated by the Spouses through a Limited Liability Company Does Not Qualify for the Election

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. See Rev. Proc. 2002-69, 2002-2 C.B. 831, for special rules applicable to married couple state law entities in community property states.

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. Therefore, the spouses must take into account the items in accordance with each spouse’s interest in the business. The same allocation will apply for calculating self-employment tax if applicable, and may affect each spouse’s social security benefits. Each spouse must file a separate Schedule C (or Schedule F) to report profits and losses and, if otherwise required, a separate Schedule SE to report self-employment tax for each spouse. Spouses with a rental real estate business not otherwise subject to self-employment tax must check the QJV box on Line 2 of Schedule E.

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 E 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.

In General, Spouses Do NOT 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. If an EIN is required, the filing spouse should complete a Form SS-4 and request an EIN as a sole proprietor.

What to Do if the 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). If you need EINs for the sole proprietorships, see above on EINs for sole proprietors.

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.

If the Spouses Elect to be Treated as a Qualified Joint Venture, How Do They Report and Pay Federal Employment Taxes?

If the business has employees, either of the sole proprietor 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 Forms 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. See above regarding the allocation of the deductions for income tax purposes.

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.