 Income tax 2023-2024. Business owned and operated by spouses. Get ready and some coffee, because the only thing certain in life is death and taxes. And the only thing certain in death is more taxes. Most of this information can be found in Publication 334, Tax Guide for Small Business for Individuals Who Use Schedule C Tax Year 2023, which you can find on the IRS website at irs.gov, irs.gov. Looking at the individual income tax formula, basically mirroring the calculation for the Form 1040, the first half of the income tax formula. In essence, a funny income statement. Most income statements having income minus expenses resulting in net income here having income minus deductions resulting in taxable income. We're focused on the first line, the income line, which can be deceiving because we're looking at a sole proprietorship, a schedule C pulling in from another schedule, which is basically another income statement, which will have income minus expenses, those expenses basically business deductions, the net income then rolling into line one income of the income tax formula. Here's the first page of the Form 1040 where we are focused on line number eight, additional income from schedule one, which is going to be coming from schedule one, additional income and adjustments to income, part number one, line number three, business income or loss, which we're coming from the schedule C. The schedule C is the profit or loss from business having in essence an income statement. First, a word from our sponsor. Yeah, actually we're sponsoring ourselves on this one because apparently the merchandisers, they don't want to be seen with us. But but that's okay, whatever, because our merchandise is is better than their stupid stuff. Anyways, like our trust me, I'm an accountant product line. Yeah, it's paramount that you let people know that you're an accountant, because apparently we're among the only ones equipped with the number crunching skills to answer society's current deep complex and nuanced questions. If you would like a commercial free experience, consider subscribing to our website at accounting instruction.com or accounting instruction dot thinkific.com format income minus expenses. Alright, we're looking at business owned and operated by spouses. This is going to provide some problems which you might think of as not an issue at first. But if you look at it a little bit more deeper, then you're saying, Hey, there could be some issues here. Why? Because if we have two individuals that are single, and then they get married, what happens? The two individual beings become one soul one entity, both in terms of soul and for taxable entities in general, shown by the fact that they're filing a single tax return, married filing joint status, as opposed to two single or head of household types of statuses. However, if they're going to start a business, usually we think of a business as either being a sole proprietor type of business in which case you have one owner, which is easy to then calculate for an individual tax return because we could just add in essence the income statement on basically a schedule C. However, if you have a partnership situation, it usually becomes more complicated, more of a problem, even if that partnership is not incorporated or an LLC or an S corporation or anything like that. Because now you have two owners, you have to calculate the net income. And then the net income usually needs to be flowing through or somehow populated in usually two different tax returns for the owners of the partnership. So a partnership adds a level of complexity just in terms of the partnership structure so that you can get to the net income, calculate what that is and then have the distribution, which might not always be easy. It might not just be a 50 50 distribution, you could have five partners with different distributions of net income based on the partnership agreement. So if they're married, then you might say, well, I don't have to do that if they're married because they're one entity. They've become one being one essence. So they shouldn't have to file a separate tax return in order to allocate the proper amount between the individuals. You could just report it on the schedule C you would think, which would flow through to the first page of the form 1040. And in essence, that's true for the federal income taxes. But you also have this Social Security and Medicare that comes into play. So Social Security and Medicare is similar to the payroll taxes that usually are withheld if you were a W two employee and they typically are not allocated as though you are one entity combined together, but rather are tied to people's individual Social Security numbers. So even though now you have a situation where you have one entity that possibly runs a business, they run it together. And they're kind of together for federal income tax purposes, not a problem. But who gets to be allocated the Social Security? That's not an issue with regards to how much they're going to pay into Social Security because the Social Security income will be the you know, the same amount of the net income on the schedule C no matter how you allocate it between partner and spouse if they're filing a joint tax return. But when you think about the distributions from Social Security at the time of retirement, it will be dependent in part on how much money was put into Social Security. And that becomes basically a big issue. So that's why we have this issue with regards to the spouses, you would think the easy thing to do would be to report it on a schedule C and combine them together. But we have these issues that come up these problems that happened, not least of which is this allocation of the Social Security, which is the self employment tax. So if you and your spouse jointly jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement. Now note that if you're a sole proprietor, remember that for taxes, the government just wants a piece of the income. You can basically think if you start a hotdog stand and you start making money, the IRS is going to say, I want a piece of it. Now you might say, again, you might say, Hey, look, I haven't done all the things I haven't. Basically, do I have to register the truck and make sure that I'm in compliance with regulations? Those are state and local regulations. Typically, even if it was illegal, even if you were selling moldy hot dogs, making people sick out, the IRS would still want their piece of it, right? That's how they think of it for federal income tax purposes. Now, if you made a loss, then the IRS is like, Whoa, whoa, whoa. Maybe it's just a hobby that you have there and you can't deduct the losses and just give us a piece of the revenue. They might say it that way, but a partnership is similar. What if two people or three people or whatever just start a hotdog stand and they're not married or whatever? Same thing is the case. The IRS is going to view you as a partnership, basically, and want a piece of the income. Logistically, it's more difficult to calculate the income because you can't just calculate it on a schedule. See if you have different people that are have different form 1040s. So therefore you have a different flow through entity, a partnership tax return, not taxed at the corporate or partnership level, but rather in order to calculate the net income and allocate according to the partnership agreement to the partners in the form of a K1, which will then flow through to the individual tax returns, which they'll pay taxes on on the individual level. Now, if you're married, again, you'd kind of think you're one entity. However, you're still two people in some sense as well. So if you're two married people that have the hotdog stand, and you own and operate it then yourselves, then in some sense, you're basically a partnership in the in the system. And the question then would be, well, do I have to file a separate tax return so that I can allocate the K ones and so on that way? So do not use a schedule C. So it says instead file form 1065. That's the partnership agreement. Now, that's the general rule. We could have exceptions to it as we will see here. So us return of partnership income. So for more information about this, you can see publication 541 partnerships. So then we have the exception community income. Okay, so if you are if you and your spouse wholly own an unincorporated business as a community property under a community property laws of a state, foreign country or US territory, you can treat the business as either a sole proprietor or a partnership. Now, this is where the state law comes into play. And so remember that the federal law is making the law with regards to the federal income taxes. But some of the definitions that they're going to have in terms of what does it mean to be property or the who owns the business? What does it mean to be married and so on in terms of property ownership that could be dependent on the state? And so that's why we have to come up with this community property under community property laws and states. So that means that you're going to need to know what state you're regulating in and whether or in territory or whatever, and whether or not it's a community property state or not in order to deal with this particular problem to see if you would have to file a separate form partnership tax return or possibly file the Schedule C. So you can treat treat the business either as a sole proprietorship or a partnership. So states with community property laws include that's Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. So a change in your reporting position will be treated as a conversion of the entity. You can see publication 5555 for more information about community property laws, exception, qualified joint venture, a QJV. So if you and your spouse each materially participate as as the only members of a jointly owned and operated business and you file a joint return for the tax year, you can make a joint election to be treated as a QJV otherwise known as a qualified joint venture instead of a partnership for the tax year. So you think that might be another way that you can deal with this, which might be a little bit more easy or easier than filing the separate partnership tax return, having the K1s and the flow throughs, which will be more complicated and more costly if you have someone else helping you with that or even if you're just buying software to do that. So making this election will allow you to avoid the complexity of form 1065 but still give you still give each spouse credit for social security earnings on which retirement benefits are based. So you might think this whole thing like why? Why do I need this whole thing? Because the federal taxes are going to basically come out the same oftentimes or possibly. When are the taxes going to not come out or you know, and again, one of the main things that we need to deal isn't the federal income taxes. It's the social security which is allocated by social security number, which will have an impact not only on the taxes that you're paying in, but also in terms of who's going to get the benefit because the benefits aren't provided by married couple, but rather by individual social security number. So for an explanation of marital participation, you could see instructions for Schedule C form 1040 line G. This also, by the way, is an area where you might end up with some tax planning type strategies. In other words, if you had two people that were married, for example, and one spouse has the sole proprietor business and the other spouse possibly was a homekeeper taking care of the home, then the second spouse hasn't been paying into social security and therefore might get very little or no social security benefits at retirement. And the person that's paying into social security might be paying the maximum in already and not getting any more added benefit in the form of benefits at the point of retirement by paying a lot more into social security. So in those situations, the question is, well, could one spouse participate in the business? If you have both spouses working in the business, would it then be in some way, shape or form possible to have the spouse that's not having and that doesn't have a lot of benefits that they're going to get at social security to allocate more of the contributions to them, which might have an impact in the future with regards to the benefit calculations that they're going to get at the point of retirement. So that gets quite complex because because when you put money into social security, it's going to have an impact on how they're going to calculate things, the laws could change over time as well. And then when you so then the question is, you know, is there some way that you can set up your scenario so that people are working in such a way that they're paying into social security to maximize the benefits which will be paid out based on how much was paid in, not according to married couple, but by individual social security number. Caution, 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. Thus, a business owned and operated by spouses through an LLC does not qualify for the elective of a QJV. So we talked about before like LLCs are an attempt to get the benefits of like both worlds, right? So in other words, when you have an assault proprietor, you have more liability, no liability protection, less separation between your business and personal entity, possibly of greater ability to get sued and and have your personal assets subject to that. One way to try to get liability to protection is to have a separate legal entity, which used to be a C corporation. But the problem with the C corporation is double taxation, taking the money out in the form of dividends resulting possibly in income as well as being taxed on the corporate level. So then you have flow through entities to try to get around that to get the best of both worlds, which take the form of possibly S corporations and limited liability companies, which typically have a separate return that needs to be filed. However, no tax at that level, rather having K ones flow through to the individual tax returns in a similar way as a partnership to be taxed on the individual level. And then with the limited liability companies, which are usually taxed in a similar way as a partnership, you might have a single member LLC that was set up, which could cause you the problem here because if it was set up as a single member LLC, then within the setup process, it's a single member. But sometimes those if they weren't a married couple might be able to be reported as a schedule C or just on a schedule C rather than having a separate tax return that flows through. But it might muddy up the process to try to make a single member LLC if you have two members, even though those two members are narrow married couple, right? So that's something to be mindful of. So to make this election, you must divide all items of income gain loss deduction and credit attributable to the business between you and your spouse in accordance with your respective interest in the venture. Now this is kind of a pain to do to basically break, you know, to allocate that all out on the tax return. Each of you must file a separate schedule C. So in other words, you would think the easy thing to do is to say, Hey, look, we're married. We're going to file one schedule C and basically allocate between the two with regards to the income for our contribution to social security, basically evenly because we're married. And we're like one, we're like one combined being at this point at the point of marriage. And you might be able to do that under the rules for the community property rules. But here, we're saying two schedule C's. So if you had a 50 50 split between the two, and you might be able to do then other splits this way. But then you'd have to report to schedule C's and take the line items of each of the schedule C's right and report your your portion of it so that the two schedule C's will then add up to the total schedule C. And you can see why that would be kind of a pain to do. But it would it might be easier than filing a separate partnership tax return. And it would properly allow you to allocate the social security between the spouses in accordance to their social security numbers, which can properly allocate hopefully the benefit calculations at retirement for social security. So for more information, you can see qualified joint ventures in the instructions for schedule s e