 Income tax 2022-2023. Business owned and operated by spouses. Let's do some wealth preservation with some tax preparation. Support a counting instruction by clicking the link below, giving you a free month membership to all of the content on our website, broken out by category, further broken out by course. Each course then organized in a logical, reasonable fashion, making it much more easy to find what you need than can be done on a YouTube page. We also include added resources such as Excel practice problems, PDF files, and more like QuickBooks backup files when applicable. So once again, click the link below for a free month membership to our website and all the content on it. Most of this information comes from the tax guide for small business for individuals who use Schedule C Publication 334 Tax Year 2022. You can find on the IRS website, irs.gov, irs.gov. Looking at the income tax formula we're focused online, one that being income. Remembering that the first half of the income tax formula is in essence an income statement. Although it's also an outline, a form of scaffolding, many other forms and schedules flowing into it. This half of the income tax equation in essence representing page one of the form 1040. When we're looking at the income line, one of the things that will flow into it would be the Schedule C. The Schedule C being an entire income statement in essence in and of itself. Income minus expenses, the expenses basically being the business deductions. Looking at form 1040. We're here on line eight other income from Schedule 1. This fluid in from the Schedule C to Schedule 1 to first page of the 1040. This is the net income, not the gross income. Here's a Schedule C, which is in essence an income statement. Income minus expenses, the net is what flowed through the Schedule 1 and to the 1040. So now let's think about a situation where we have a business owned and operated by spouses. So in other words, when we think about a sole proprietorship, we typically think of one individual that's starting a business. One individual, for example, that starts a hot dog stand is for tax purposes in essence automatically a sole proprietorship, because they started generating money and they didn't incorporate or have some other form of operation and therefore they're a sole proprietorship and the IRS wants a piece of that hot dog stand. But if you have two or more people that started the hot dog stand, now you are in essence a partnership. So if you're just doing a profit sharing situation with two or more people, the problem is you can't just report that information on the Schedule C because you have different people reporting different Schedule C's and therefore normally you have to report a partnership return, which is a flow through type of entity, meaning you're not taxed on the partnership level, but rather you have to do a partnership information return in order to generate the K1s, which are kind of like W2s from the partnership in a sense that they're going to report your income, except it's going to be the full income that flows in through to the partners who can then use the K1s to report their share of the income on their forms 1040. But what about a marriage situation? That's an interesting situation because the general idea would be for tax purposes, you had one entity or two separate entities to start with and then they got married. So they should be one taxable entity. They were two, now they're one. Isn't that the blessing of marriage and whatnot? But for taxes, it gets a little bit more messy than that in part, not just because of the income tax situation because you might say, well, who cares if the income is received by one spouse versus the other spouse because it's going to be reported on their joint income tax return possibly. However, the Social Security becomes an issue because when you report the income for a sole proprietorship on a schedule C, you're also going to have to be paying the Social Security taxes and you might say, well, who cares? It's going to be one entity paying the Social Security tax and it's the same rate, same cost. But the benefit of paying into the Social Security program will result in you getting Social Security payments calculated at the end of the Social Security program. And that is based not on a marriage basis, but on an individual's basis, meaning it's laid out by person by social security number. So that becomes an issue. How are we going to be allocating the income that's being paid for the self-employment tax? And obviously from a tax planning standpoint, we would like to do so. So it maximizes the amount of Social Security benefits that we're going to be receiving at Social Security time. So we have that to deal with as well. When we have this partnership spouse with one business, those are some of the issues that cause some of these problems. So if you and your spouse 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 whenever you go into business, like if you just started your hot dog stand with two or more people and you didn't make any other agreement then you might just have a verbal agreement or you might basically just split the revenue evenly through however many of you there are. But clearly it would be much better to set up any formal agreement. And people often kind of don't do this with people that they know like family for example because they just assume that their family members family family can read their mind because they're so close in this knot. And that's in my opinion and in my experience, horrible idea. You want to lay out exactly what everybody basically is expecting from the partnership. So everybody's on the same page and we don't have any kind of bad feelings that people are not are being taken advantage of within any kind of partnership arrangement. And I would think that would a marriage if you could be more open about that kind of partnership in terms of what your expectations are and what you're looking for then that would be good. But obviously if you're a married couple even that's going into a business setting it's quite natural to think well my spouse can read my mind and so we don't need a formal agreement. But you probably want a formal agreement just to make sure everyone's on the same page here. So do not use a Schedule C instead file form 1065 US Return of Partnership Income for more information see publication 541 partnership. Now there is an exception here. So if you're in that situation you might have to you could file a partnership return even though it's two spouses that own the what would be sole proprietorship type of business which would now be designated a partnership in that situation. Here's an exception community income. So if you and your spouse wholly own an unincorporated business as community property under the community property laws of a state foreign country or US possession you can treat the business either as a sole proprietorship or a partnership. So states with community property laws include Arizona California Idaho Louisiana Nevada New Mexico Texas Washington and Wisconsin. So now you've got to go down to the state law and say what does it mean to be married from the state perspective. And remember that there's a differentiation from between federal law and the state law and the marriage contracts are typically under state law designations and whatnot. So then you've got this designation of community property states or non community property states. If you're in a community property state then then you may be able to do this a little bit more easily with spouses that own and operate a business by just by having a schedule C C business and hopefully be able to and then again there's no big problem with the income tax really. The issue comes in with being able to allocate properly the social security taxes in a way that you can kind of maximize the social security benefits that are going to be allocated out to the two individuals in the partnership the two spouses in this case. So a change in your reporting position will be treated as a conversion of the entity C publication 555 for more information about community property laws. So exception qualified joint venture. So here's another type of exception qualified joint venture. So if you and your spouse each materially participate as the only members of a jointly owned and operated business and you file a joint return for tax year you can make a joint election to be treated as a qualified joint venture instead of a partnership for the tax year. So making this election will allow you to avoid the complexity of form 1065 the partnership tax return a whole another entity tax return but still give you each spouse credit for social security earnings. Now that's the key. So again that's a key that whole social security earnings things could be a big deal because of the benefits on which your retirement benefits are based. So for an explanation of quote marital participation in quote see the instructions for schedule C line G 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 election of a qualified joint venture. So if you're an LLC the issue with an LLC was that normally an LLC is like a part is taxed kind of like a partnership with a separate legal entity but we thought we saw that sometimes you might have a single member LLC and if you were a single member LLC then possibly you can still file a schedule C even though you have the single member LLC which hopefully is there to give you some more liability protection perhaps but if you're if you're like two spouses you might not be able to do that single member LLC situation however you may still be able to do a normal LLC which means you'd be filing in essence like a partnership another entity type of return which would be more complex than just a schedule C situation. 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 with your respective interests in the venture. So if it's a 50-50 thing you'd have to split it all up or whatever the agreement is each of you must file a separate schedule C and a separate schedule SE. So that's a bit tedious obviously but it might be easier than another than having a whole nother form that partnership return. So for more information see qualified joint ventures and the instructions for schedule for schedule SE that's going to be the self-employment tax.