 Income tax 2021-2022. Business owned and operated by spouses. Get ready to get income to the max. Dive into income tax 2021-2022. Most of this information can be found in Publication 334 Tax Guide for Small Businesses on the IRS website and irs.gov, irs.gov. Income tax formula looking at the first line, the income line. However, we're imagining a separate schedule, a Schedule C which has income and expenses, expenses in essence being deductions, the net income rolling into this top line of the equation as well as the first page of the form 1040 that we see here. Line number eight is where our focus is. Other income from Schedule 1, the Schedule C then would flow through to Schedule 1, flowing through to the first page of the 1040 we see here. Here is the Schedule C profit and loss from businesses. Basically an income statement which the net income flows through to Schedule 1 and then flows through to line 8 here of other income on the form 1040. We're looking now at a business owned and operated by spouses. So the question here is well if you have two people let's go over the general rule and then we'll take a look at exceptions to the general rule. The general rule is if you are a sole proprietorship and you just start making money, you just start doing business and you start making money, you don't do anything else. The IRS of course thinks of themselves as your silent partner and they want you to file a Schedule C and give them some of your money. If you're a partnership and you just have two or more people that you just start doing business with and you don't have any agreement or anything like that which I don't recommend by the way if you are a partnership and you start making money, you want to say what is the agreement even if I don't care how well you know each other and whatnot. I would recommend set up the agreement who's doing what, who's putting in how many hours and what's going to be the revenue split. Do we all agree on that? Write it down because at some point in the future there's going to be confusion, miscommunication and when that happens it's not good for the partnership. So I would say you'd want to write down the articles and whatnot but if you didn't then in theory the IRS would of course just assume you to be a partnership which is easy to set up in that case but it's a little bit more confusing to do the taxes because you can't just put a Schedule C return in place because that would be one attachment to one return but in that case you would be a partnership. So you'd have to basically have a partnership return that you would have to create that would then have the net income that flows through to the individual partners so it would be a flow through entity is what we call it so we can calculate the net income but not be taxed on the partnership level it would then flow through to the individual partners with a K-1 form and then taxed on the individual partners tax returns and so on and it could still have self-employment tax implications and so on at that point in time. So then you've got the question well what if like it's a married couple like you just got a married couple that's doing businesses now you've got two people that are basically a partnership but it seems like kind of a pain it's a lot more of a pain to do a partnership return and then a flow-through kind of thing because you're gonna have to pay for the partnership return which is gonna cost more and the K-1s and the flow-through and so on and if it was just a partnership between spouses you would think well we are already kind of treating them as one entity for taxes because they're filing married filing joint so you would think the easiest thing to do would be say can't I just file a schedule C in that instance instead of a partnership return. So we'll start off with the general rule which is basically no and then we'll get into kind of the exceptions to that rule also just realize there's another caveat to just kind of think about that you might say well why why wouldn't I be able to do that given the fact that if I had a partnership return then the K-1s would flow through to my individual return which would be my married filing joint return and I would be reporting it you know in married filing joint anyways. The other thing you got to kind of consider is the self-employment tax that's going to be involved because even though you're going to be paying the same amount of self-employment tax it becomes important to determine which who's getting allocated the self-employment tax which which spouse is being allocated the payment of the self-employment tax because in total you're going to pay the same amount but it'll have a it'll have an impact in terms of who got the credit for the self-employment tax when you get to the distributions of self-employment at the point of retirement so that becomes important for for retirement kind of planning you got to think about okay how can we maximize the distributions of the self-employment tax and that calculation is based on how much money somebody put in and so that that means that you got to make sure that you're thinking about who's going to get the allocation of the self-employment tax which spouse okay so in general this is the general rule then we'll look at exceptions if you and your spouse jointly own and operate an unincorporated business and share in the profits and losses you are a partnership in you are partners in a partnership whether or not you have a formal partnership agreement that's kind of like the general rule that you if two people are just making money then you're basically a partnership they're saying the general rules the same thing even for the spouses here do not use the schedule see so I'm not in that instance you'd see you can't just attach the schedule see if that was the case that we're going to be working under instead you'd file the form 1065 which is the US return for partnership income and then you can look at for more information for that that that form on publication 541 but in essence it would be a flow-through entity form reporting but not actually paying taxes on it in general although the state could try to try to tax you on it in some way or charge you a fee quote but and then it would flow through into your tax return and then you pay the taxes there but now we have the exceptions exception we have the community income exception if you and your spouse wholly owned and incorporated 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 that includes Arizona California Idaho Louisiana Nevada New Mexico Texas Washington and Wisconsin so if you're in those states and you have a partnership that is the two spouses you might then fall into this exception of the community property income and those states so if you're outside of those states then you're not going to possibly fall into the same exception because this community property law stuff is coming down to the state law and so and again those states that have the states with community property include Arizona California Idaho Louisiana Nevada New Mexico Texas Washington and Wisconsin so a change in your reporting position will be treated as conversion of the entity so let's let's read that exception one more time if you and your spouse wholly owned and unincorporated business as community property so you wholly own it community property under the community property laws of a state foreign province of the US possession you can treat the business as either as a sole proprietorship or partnership and so in that instance it might be easier you know to treat it as a sole proprietorship because it's going to cost you less to do the tax returns and so on be easier to fill out one one schedule C as opposed to the flow through kind of thing so we have another exception we have the qualified joint venture qualified joint venture exception if you and your spouse each mutually 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 for the tax year so now we got a qualified joint venture making this election will allow you to avoid the complexity of form 1065 the partnership return but still give each spouse credit for Social Security and this again big this is a big factor it might not seem like a big factor when you're just looking at your income taxes but it has a big impact on or can have a big impact on the benefits so you want you want to be thinking about how can how can it seems kind of because it's like a safety net program it seems kind of like game in the system when you're talking about trying to get benefits from some it can but again we're not really sure these days in the U.S. whether the Social Security is a safety net program or like a retirement program it's kind of in between so you want to kind of maximize your benefits from the Social Security and the way to do that is to try to figure out between the two spouses who should you know who's going to have the out you want to fairly allocate the payments because it's going to have an impact on the on the Social Security payments that are going to go out in the beneficiary time period unless Social Security completely collapses which it's destined to do at some point unless something changes but it'll stumble on for at least a while longer give me at least like 40 more years you can hang in there but still I give each spouse credit for Social Security earnings on which retirement benefits are based so for an exception of quote material participation in quote see the instructions for schedule C line G so only businesses that are owned and operated by spouses as co-owners and not in the name of a state law entity 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 in other words you might say okay now can I set it up as a as an LLC because we saw an exception for the LLC is an attempt to get the liability protection but if you're only a single member LLC you could try to file as a single member LLC and still have possibly the ease of filing a schedule C but if you're an LLC and your partnership now then you know this exception doesn't really apply so now you got a not a single member LLC in that instance you might have like a multiple member LLC which in that case you'd have to then once again file most likely a different another return and deal with the flow through kind of stuff there's arguments in terms of how big how how impactful the corporate shield is the liability protection is for a single member LLC as well so you know there's questions about that there's constant debates on on that so so usually when you try to get the liability protection and step it up that usually ends up making you forcing you to file a different entity a flow through entity or something which of course adds complexity with setting up the LLC and setting up the or the S corporation and then doing the taxes each year and again it's it's more difficult to deconstruct and just realize that of course if you're dealing with someone that sets up LLCs and S corporations and whatnot they're going to be really into setting up LLCs and S corporate because that's what they do so you want to get you want to make sure when you're thinking about these different types of entities that you're getting a third party opinion about them as to the pros and cons of of them continuing on with the exception qualified joint venture to make this election you must divide all items of income gained loss deduction and credit attributable to the business between you and your spouse in accordance with your respective interest in the venture each of you must file a separate schedule C and a separate schedule S E so notice you're still basically on the same return here but you've got two schedule C's that are being refined being filed in this instance and you can see how that would be a little bit easier to do with the software and calculate the the the self-employment tax so it's a little bit possibly easier once again than having a separate return but it's it's not quite as easy as having like one schedule C so now you've got the two schedule C's that are being reported and that of course helps you to file and allocate the self-employment tax to the spouses appropriately so for more information see qualified venture qualified joint ventures and the instructions for schedule S E