 Income tax 2023-2024, business owned and operated by spouses, tax software example. Get ready and some coffee, because if taxes are an animal, the government is definitely a leech. Ew, get it off! We're trying, we're doing what we can. Here we are in our form, 10-4. 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 that's okay whatever, because our merchandise is better than their stupid stuff anyways. Like our CPA six-pack shirts, a must-have for any pool or beach time, mixing money with muscle, always sure to attract attention. Yeah, even if you're not a CPA, you need this shirt, so you can like pull in that iconic CPA six-pack stomach muscle vibe, man. You know, that CPA six-pack, everyone envisions in their mind when they think CPA. Yeah, as a CPA, I actually and unusually don't have tremendous abs. However, I was blessed with a whole lot of belly hair. Yeah, allowing me to sculpt the hair into a nice CPA six-pack-like shape, which is highly attractive. Yeah, maybe the shirt will help you generate some belly hair too, and if it does, make sure to let me know. Maybe I'll try wearing it on my head. And yes, I know six-pack isn't spelled right, but three letters is more efficient than four, so I trimmed it down a bit, okay? It's an improvement. If you would like a commercial-free experience, consider subscribing to our website at accountinginstruction.com or accountinginstruction.thinkific.com. For the example, problem using LASERT tax software. You don't need tax software to follow along, but if you have access to it, it's a great tool to run scenarios with. You can also get access to forms, schedules, instructions at the IRS website, irs.gov, irs.gov. Starting with our standard starting point, taxpayer Adam Taxman, just trying to avoid a dang Taxman, living in Beverly Hills 90210. We're going to start off as single and then add some complexities as we go to married filing joint, starting with no dependence, starting with W-2 income of 100,000 that we will then change to business income in our example problem. We've got the standard deduction $13,850 getting us to the taxable income $86,150, which we can mirror over here on our income tax formula in Excel, $100,000 income $13,850 standard deduction $86,150 taxable income tax calculated at by the software $14,266, which is on page two of the form 21040-14266. All right, let's go back to page one. We're going to add some complexity, one being that we're going to have the Schedule C income as opposed to the W-2 income. And then two, we're going to imagine that we have a married couple and how are we then going to allocate the Schedule C income between the married couple? And why does it even make a difference? Because you might think, hey, look, we're married. If we're married, we have become one entity. We are now one. And for tax preparation purposes, that's why we changed the filing status from single to married filing joint instead of filing two separate tax returns, filing one tax return. And then we would put our total income here from the Schedule C just as we would if it was a single file or what's the big deal? What's the problem? And the main difficulty here will lie in the self-employment tax, which is equivalent or similar to the social security and Medicare, which are the payroll taxes that are withheld from your wages. So that is still allocated by social security number, which complicates the situation. So then the question is, all right, if there's only one person that is in control of the Schedule C, then you can just file the tax return for federal income taxes and assign all of the income to one social security number for social security. And that's pretty straightforward. But if both of the people, the partners, both of the married couple are involved in the business, then how are you going to divvy up the social security between the two? Typically that is done with a separate return, which is going to be a partnership return, which will then calculate the net income on a partnership level, but not pay tax on that level, and then flow through with the use of the K-1 forms to the tax return on the individual level, which in our case will be going to the same form 1040, but coming from both spouses, the K-1s then allowing us to allocate the social security properly between the two individuals. Now that would be fine, but tedious, because you'd have to hire someone to file a partnership tax return, most likely, which they're going to charge a lot more for. And then also the individual tax returns and probably have to pay more per K-1 that you're going to be entering, or if you do it yourself, you're still going to have to probably buy the partnership tax return, because it's a little bit more difficult to get that software than just individual software if it's a basic kind of tax return. So then the question is, well, how can we get that on one return? And it might differ depending on whether you're in community property states or not. Now before we dive into that, you also could have tax planning kind of issues with regards to the social security. So let's first look at social security for just a W-2 employee, for example. So you could see here that we have social security $100,000. Social security is calculated automatically at 6.2%. So we're paying in 6,200 social security $1,450 for Medicare. So that amount, if we're W-2 employees, is taken out automatically. We probably don't think about it much, but it's also going into our social security benefit calculation so that when we get money back from social security, the more we put in, the more we should basically get back. And so that's going to be important in terms of the retirement time frame. So now I could say, well, what if social security went up to like $200,000? You can see now it's going over the cap of $160,200. And so now it's really capping it at $160,200 instead of paying social security at 6.2% of the full $200,000. Why would that be? Because the social security calculation is a complex mess, is basically the answer. And if it goes over a certain threshold, you're not getting any more benefit in terms of the receipt of the social security. And that's part of the rationale why it's going to be capped at that point in time, because we can't figure out whether or not social security should be a benefit program or like a safety net program. Is it a retirement program for everybody or a safety net program? And so we have this kind of a messy situation. But that becomes an issue when we're trying to allocate social security between two individuals. So let's imagine, for example, that we get there married now. So now we're going to say single married filing jointly. And so I go back to my W2 income. And so now we can see that we could still have one person that has the $100,000, and they would be paying the 6.2, which would be allocated to that person's social security number. And in this case, it's going to be going to the Adam Taxman's social security number for the social security. If I look at the tax calculation, $100,000, but now the standard deduction is up because it's married, it's been doubled. So if I reflect that in my formula here, we could say, okay, now it's $27.7 bringing the taxable income to $72.3. So we have the $72.3. And then on page two, $8,239. So we're going to say our $8,239 is where we stand at that point. So then I could say, well, what would happen if I split this income up between the two? So W2. So now we're going to say W2. And this one is for the spouse of $50,000. So $50,000 and $50,000, let's say, we still come out to that $6,200 of the social security, which is 6.2% of the $100,000. $100,000 times $0.0626,200, which and our total income, as you would expect or would think, because we're one entity now, is still $100,000, $27.7, the $72.3, that's the same thing we had before. And our tax calculation, $8,239 is the same. So that's kind of what we would expect in terms of federal income taxes. And note that if I shift this to like $60,000, $40,000, then I'm still going to get this $6,200 that's paid into social security. I should still get basically the same result here, $100,000, $27.7, $72.3, and then on page two, $8,239. However, now that means that more has been paid in for social security benefits for the Adam versus I think Jane, the other, right? And that's going to have an impact on the payout. So we're going to have a similar kind of situation when we try to allocate between the two individuals for a schedule C. So in other words, you might also say, well, what if I had $200,000 up top and zero here? What's going to happen? Well, then it gets capped at 160,000. That's where the cap is, meaning we don't pay any more than 9,932. However, if you talk about higher income individuals, if I split that evenly, $100,000 and $100,000 between the two of them, now you've got $200,000 between the two, and they both pay $6,200 because that cap is applied per social security number. So that's one thing you have to keep in mind. There's a cap. So when you get to higher income individuals, we have two things that are kind of involved here. If I have a schedule C business, you might want the spouse to be allocated some of the income so that we're paying into the social security so they get a benefit when they pay out. However, if we're hitting the cap, if we're way over the cap, then it would almost be better to have it allocated to one social security number so that you're not paying more into social security than you absolutely have to, given the fact that the thing is basically bankrupt. All right, so keeping that in mind, we're going to say, okay, let's close this out and let's change the income now to a schedule C. So I'm just going to say it's a schedule C business. I'm just going to just enter the income for it. Let's say it was $120,000 and then our advertising was $20,000 to give us that same $100,000 and I'm going to, what does that look like? All right, so we're going to say, all right, then the form 1040 page one, we don't have the 100 up here but rather down here, that's pulling ultimately from the schedule C. The schedule C is an income statement. There's the 120 minus the 20. I'm going to get rid of these check marks. Gets us to the 100,000. That then is going to pull into the schedule one. There's the 100,000 that pulls into the form 1040. And there's the 100,000. We also have this the social security. So basically that 100,000 is going to go to this social security, which is all allocated to Adam. That's the point. So 100,000 is being allocated to Adam social security calculated at the 14129. So if I go back to schedule two, there's the 14129, the 1040, page two, there's our taxes, federal income tax, there's our social security, total tax between the two, $19,950. Half of that social security then is deductible on the schedule one, page number two, there's the 7,065, which is rolling into the form 1040. So now we have the 100,000, the above the line deduction or adjustment to income 7,065, getting us to adjusted gross income 92935, 27,700 because married standard deduction. We also have the qualified business income deduction 1347 calculated by the software subtotal 40,747 gives us the taxable income 52188. If I go to page two, calculate in the tax, and then there's the self employment tax. Now you might say, well, what if they're married? So what if I say it was a if I allocate it between the two of them, it should be the same for federal income taxes. But again, we run into that social security issue. Now we also have to think about the state, because we have to think about whether it's community property or not. So for example, if you and your spouse wholly own an unincorporated business as community property under the community property laws of a state foreign count country or US territory, you can treat the business as either a sole proprietorship or a partnership. So proprietorship would be our preference possibly because it would be a little bit easier maybe. So now we're thinking it's not just one spouse's business, both of them are participating in it. So so we're gonna say, okay, so do I have to file a partnership return? I'd rather not. Can I allocate it evenly between the two partners given the fact that we're married or whatever. So states with community property laws include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. So if you're in one of those states, then you might be able to do like the community property law calculation. And possibly you can go back on over here and do the easy thing, which is to say I'm just going to go from taxpayer to joint. So by the way, if I went to spouse, then it would just basically say that's the second person that's listed on the tax return. So in our case, Adam and then Jane. So now when I look at the schedule s e, it's allocated to Jane because Jane's the one who social security number is there. The the actual tax calculation is the same for federal income taxes, right? It's going to come out the same way. But now for social security benefits, all of the income has been allocated to the second social security number to Jane. What if I want it 5050? Well, if it's community property, it would be nice if I could just say it's joint because we're 5050, you know, partners as a as a married couple or whatever. So we're going to say, all right, could I do that? What would that look like if that were possible? Everything looks the same for federal income taxes, same calculations here, same calculations here. But when I look at the schedule s e, notice I have two of them now, which basically just took the net income and divided it by two, which is what you would expect. And so we have our calculation here allocated out properly. And then Jane has been allocated out very nicely. Now, again, if this could be an issue, however, if your income is high, and one person would have hit the cap. So in other words, if I if I go up to 200,000, 200,000, if that was all allocated to one person, they would have hit the cap for social security. If I allocated to two people, let me hold on a second. That's the income, let's say 220,000, which will net out to 200. So so now I've got the schedule C is netting out to 200,000. The schedule s e is is allocating 100,000 each, right 100,000 each. Okay, and then if I go so that comes out to to total on page two of the form 1040 for for the other taxes, 28,258 allocated between the two of them. Let's let's mark that down. So 28 28258. Now it's great that it's that the benefits are going into both people's social security. So the benefits that they'll receive will go up for both. But it's like, well, wait a second, if I if I only allocated this to one versus to both of them, if it was just going to one, one of them versus both of them, and I go back on over, you could see that I have less tax here, right, because now it hit the cap for social security, not for Medicare. So if I go back into that, that schedule s e, you could see the 200 is here, but then it hit the cap for social security. So that's where you have to be careful. That's where you could have some planning involved here, which would be like, if for example, one spouse was was paying into social security, and the other was not because they were a homemaker, then you're like, okay, well, that second spouse isn't going to get any benefits for social security, because it's not being paid to that that social security number. So you might say, well, it would be great if if we can have the spouse working for the business so that we can properly allocate them some income, which would be going into their social security calculation, which could increase their benefits. So that would so you're going to go, oh, that would be good. But if I make a lot of money, like over the cap amount of money, then that means that in total between the two of us, we might end up paying more money into the social security than we otherwise would if it was all allocated to one person, which you which you might not want to do, given the fact that the social security is not an efficient way to save for retirement, and it might go bankrupt, and you would think the law is going to change later at some point. Anyway, so those are kind of like you have to be careful if you go over a certain threshold in terms of what would be better with regards to the allocation between the two in terms of if you have like a business or if you're thinking about having the two people participating in the business and what's the social security calculation. Now, you could also say, well, what if they were they have an election, maybe they're not in a community property state or something. 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 the tax year, you can make a joint election to be treated as a qualified joint venture instead of a partnership. So now you're going to say, well, one, maybe I maybe I don't want to do the community property thing allocating evenly, possibly because it's not an even allocation, maybe it should be like a 6040 given the participation and the partnership, or maybe I can't do the community property thing at all, because I'm not in a state that allows me to do the breakout we had before, which would be the easiest thing to do. So instead of doing a separate partnership return, maybe I can do a qualified joint venture. So making this election will allow you to avoid the complexity of form 1065 partnership return, but still give you give each spouse credit for social security earnings on which retirement based. For example, we could see an example. So how so how would we do that? So it says 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 interests. So that becomes kind of a pain to do it's a lot more of a mess, because we'd have to file separate schedule C's right so now I'm going to say all right, I'd have to go over here let's imagine that I had my schedule C calculation, which was like 120,000 income, 20,000 of expenses, and then I'm going to kind of break it out. Let's say it was broken out 6040. So I'm going to have to go okay 6040%. On each line item is going to be this times 60, and then this times 40. And then I'm going to say this is going to be this times 60, and then this times the 40. And if I add those up equals the sum, and that's the total equals the sum to duh, and that's the total. And then I have like this minus this, and then I have to do something like that and go okay. And then this minus this and then the sum of this right I have to do something like this so that I can then go over here on each line item, and go Okay, now I've got the tax return for the taxpayer. And then I'm going to go into add another one and have one for the spouse. And then on let's say on the first one, let's say it was 60 each. So I'm going to say it's going to be according to my worksheet, right, we've got 72,000 72,000. And then we're going to say I have 12,000 here. So 12,000. And then on the spouses side of things, we're going to say this is the spouse and there we had 48,000 and 8,000. So 48,000 and 8,000. And so if I go back on over, now we've got the schedule C to schedule C's, not just a breakout of one schedule C then feeding into a schedule SE breaking out the social security Medicare evenly. Now we've got two schedule C's. So we have, of course, the first one, if I did this right, it should add up 72 minus 12 gets us to the 60,000. So that's going to be this bit. So we took the total from the business QuickBooks or whatever from their income statement, and we broke it out 60 40 each line item. So 60,000. And then I go to the second one, which is allocated to Jane. And so she has 48,000 and 8,000. That adds up to 40,000. The 40,000 and the 60,000 adds up to 100. And on the self employment, then we have the two self employments, which are allocated based on the two schedule C's, and we can break out the proper allocation to these social security this way. So this gives you a little bit more control over kind of like a kind of like a partnership agreement, you know, like a little bit more control on on who's being allocated what, which is nice. And it does allow you not to have to file a separate tax return, which is nice, because that's a problem that takes, but it's somewhat tedious to do two schedule C's, because you can imagine that if you had like a home office here, and you had depreciation that you have to deal with, and you had the auto miles and whatnot that breaking out each line could be could be kind of a pain. So so there's kind of pros and there's pros and cons with that. So those are just a couple of notes on on that when you when you're dealing with a married couple, bottom line is married couple, the social security becomes the issue. Do you have to file a separate partnership tax return? Possibly not, but it might be dependent on the community property state or not as to how you can deal with it. And the things you want to keep in mind is the social security to maximize the benefits when social security is paid out, while also minimizing how much you can pay into social security, remembering that higher income individuals are going to hit that cap, which could increase if you divide the income between two people, which could result in paying more money into the social security, which you generally don't want to do, even though it would increase your benefits because I don't trust the social security system.