You and Your Spouse Own a Business Together. What are the Tax Issues?

    Ahhhhh……….The Husband and Wife owned business.

    Love, love, love……….

    A man and a women holding hands.

    No one knows for sure how many businesses in the U.S. are co-owned by spouses.

    A professor from Oklahoma State University estimated in 2000 that there were 3 million such businesses, so the number today likely is much higher.

    Some giant corporations — Fiji Water, Forever 21, Panda Express, and Houzz — were founded by husband-wife teams.

    There are many personal issues that couples face when co-owning a business.

    Here are some of the tax issues that spouses co-owning a business should think about.

    Tax Filing for Spousalpreneurs

    A couple who co-owns and operates a business that is unincorporated and shares in the profits and losses are in a partnership, whether or not they have a formal partnership agreement. Usually they must file a partnership tax return, Form 1065, as well as report the income, losses, etc. on their personal return. However, they can elect to file Schedule Cs along with their Form 1040 instead of Form 1065, saving them from the complexities of the partnership return. To make this election:

    • Both spouses must materially participate in the business, which essentially means working on a day-to-day basis. (Material participation tests can be found at the IRS.) Neither spouse can be merely an investor.
    • Each spouse must file a Schedule C to report his or her share of income, gain, loss, deduction, and credit attributive to the respective interests in the business. If they split things equally, then both Schedule Cs will look the same.
    • Each spouse must file a Schedule SE to pay self-employment tax on his/her share of the net income from the business. This is the same action that would occur if the couple had filed a partnership return.

    Divorce

    It’s not uncommon for spouses who co-own a business to get divorced. What happens in the property settlement? Some spouses continue to co-own the business after divorce. Others may transfer interests to the other so that only one spouse owns and runs the business after the couple splits up.  How the business interests are addressed all depends on the couples involved.

    From a tax perspective, the transfer of property incident to divorce is tax free. This means the transferring spouse does not recognize any gain or loss on the transfer to the other spouse. The spouse who now owns the business steps into the shoes of the other spouse when it comes to tax basis, so that if the business is later sold, the recipient-spouse recognizes the gain on any appreciation the transferor-spouse had but did not recognize at the time of the property settlement.

    If spouses try to co-own and run a business after the divorce but it doesn’t work out, they can still part ways tax free. That’s what happened recently to one couple who had co-owned three dance-related businesses. After 17 months following the divorce, one party bought out the other for $1.6 million, and the Tax Court said this wasn’t a sale but rather part of the property settlement.

    Innocent Spouse Relief

    Spouses who co-own businesses typically file joint tax returns. These tax returns include the couple’s business income. By filing jointly, each spouse is jointly and severally liable for the tax due on the return, plus any interest and penalties. Can an owner obtain innocent spouse relief for the actions of the other spouse? Seems so.

    In another recent case, one spouse was the sole owner of the business; the other handled the books and all other back-office operations. This spouse routinely had the tax return prepared and, after obtaining the other’s signature, filed it. The problem: She didn’t file it one year and he was assessed interest and penalties (she had died by this time). While he owed the tax, the Tax Court gave him innocent spouse relief for the interest and penalties.

    Bottom Line

    Spouses who co-own businesses should have very good lawyers and tax professionals so that each spouse’s interests are protected.

    Solid Tax Solutions (SolidTaxSolutions.com) is skilled in such matters and can be reached year-round at: (845) 344-1040.

    __________________________________________________________________________________________________

    Bruce – Your Host at The Tax Nook

    Our Firm’s Website: SolidTaxSolutions.com.

    Other Social Media Outlets: Facebook.com/SolidTaxSolutions.

    Twitter: Twitter.com/@SolidTax1040 (BTW, We Follow-Back).

    ARE YOU SELLING YOUR HOME?

    Ahhh……Summer Is Here!

     

    Summer is typically a “hot season” in the home sale market. Young families typically want to get settled in a new home before school begins in the fall, and older home sellers in northern climates want to head south before winter sets in. People who are buying a new home will need to do some serious number crunching to determine what they can afford to pay and how they will pay it. However, those of you who are home sellers will need to do some number crunching as well.

    Under current tax rules, a loss on a home sale is not deductible. On the other hand, the first $250,000 of gain on a home sale is excluded from income. What’s more, for joint filers, the exclusion is generally doubled to $500,000. However, for long-time homeowners, even those generous exclusions may not shelter all of that gain from tax. Therefore, you will need to:

    Get Back to Basis

    To properly determine gain (or loss) on the sale or exchange of a home, a taxpayer must know the basis of the home for tax purposes. And calculating basis will involve information that dates back to the time the home was purchased. Or perhaps even earlier.

    The amount of gain or loss on a sale is determined by comparing the amount realized on the sale to the adjusted basis of the home. If the amount realized is greater than the adjusted basis, the difference is a gain. If the amount realized is less than the adjusted basis, the difference is a loss.

    Cost Basis

    In most cases, the starting point for determining basis is the cost of the home. So, if a home was purchased from the builder or from a former owner, the initial cost basis includes the purchase price and certain settlement costs. The purchase price generally includes the down payment and any debt, such as mortgage or notes given to the seller in payment for the home.

    Settlement fees or closing costs associated with the purchase of the home can be added to basis. However, fees associated with a mortgage on the home (e.g., appraisal fees, costs of a credit report or mortgage insurance fees) are not added to basis. In addition, escrow amounts for payment of future liabilities are not included in the basis of the home. Some examples of settlement fees that can be added to basis include:

    • Abstract of title fees
    • Charges for installing utility services
    • Legal fees (e.g., fees for a title search and for preparing the sales contract and deed)
    • Recording fees
    • Survey costs
    • Title insurance
    • Transfer taxes

    When a home changes hands, real estate taxes for the year of the sale are apportioned between the buyer and seller based on the number of days each of them held the property during the year. The date of the sale counts as a day the property is owned by the buyer. Real estate taxes for the year of sale may increase or decrease basis, depending on how the taxes were handled at the closing. If the buyer paid taxes owed by the seller and was not reimbursed, the taxes increase the buyer’s basis of the home. If the seller paid taxes owed by the buyer and was not reimbursed, the taxes decrease the buyer’s basis of the home.

    In the case of a home that was constructed by or for the taxpayer, basis includes the cost of the land plus the construction costs. However, if the taxpayer did all or part of the construction personally, basis does not include the value of the taxpayer’s own labor or the value of any other unpaid labor. 

    Basis Other Than Cost

    Special rules apply in determining basis if a home was acquired other than by purchase or construction—for example, as a gift or inheritance or as part of a divorce settlement. In addition, a taxpayer may have a basis other than cost if a home was acquired as a replacement home in a home-sale rollover under prior law. 

    Adjustments to Basis

    A taxpayer’s basis in a home is not static. Basis may be adjusted upward or downward to reflect expenditures made in connection with the home or payments or other benefits received.

    Improvements that increase basis include:

    • Additions to the home, such an extra bedroom or bath, a family room, a deck or patio, or a garage.
    • Landscaping and other outdoor improvements, such as a new driveway or walkway, fences and walls, a sprinkler system, or a swimming pool.
    • Systems improvements, such as a new heating system, central air conditioning, a new furnace or ductwork, wiring upgrades, a septic system, a water heater or water filtration system, a satellite dish, or a security system.
    • Exterior improvements, such as new storm windows or doors, roof, siding or shutters.
    • Interior improvements, such as built-in appliances, kitchen cabinetry, flooring, wall-to-wall carpeting and insulation.

    CAUTION: Improvements that are no longer part of a home are not included in the home’s basis.

    Example: John Smith bought his home for $200,000 in 2005. In 2006, John added a deck to the home at a cost of $6,000. In 2012, John remodeled the home, which involved removal of the deck and the addition of a new covered porch. The addition and porch cost $30,000. Result: After the addition of the deck in 2006, John’s basis in the home increased to $206,000. However, after the deck was removed in 2012, it was no longer included in the home’s basis. Therefore, John’s basis for the home following the remodeling is $230,000 ($206,000 – $6,000 + $30,000).

    Some examples of repairs that do not increase basis (unless they are part of an overall renovation or remodeling) include interior or exterior painting, fixing gutters, repairing leaks or plastering, and replacing broken windowpanes.

    AND HERE ARE 11 ADDITIONAL ‘HOME SELLING’ TAX TIPS:

    1. Generally, you can exclude a gain from the sale of only one main home per two-year period.
    2. If you can exclude all of the gain, you probably don’t need to report the sale of your home on your tax return.
    3. You can choose not to exclude the gain from a sale. If you expect to sell another main home within two years, you may want to consider claiming the gain on sale of your current main home instead of excluding the gain. You can only claim an exclusion on the sale of your main home once every two years (See Tax Tip #1). Depending on your specific sale, it may be more beneficial to claim the current gain as income and use the exclusion on the future sale of your main home.
    4. If you can’t exclude all of the gain, or you choose not to exclude it, you’ll need to report the sale of your home on your tax return. You’ll also have to report the sale if you received a Form 1099-S – Proceeds From Real Estate Transactions.
    5. If you have more than one home, you can exclude a gain only from the sale of your main home. You must pay tax on the gain from selling any other home. If you have two homes and live in both of them, your main home is usually the one you live in most of the time.
    6. If you received the First-Time Homebuyer Credit when you purchased your home, you may have to pay some or all of it back.
    7. If you didn’t live in the home the entire time you owned it, you may have to pay tax on part of the gain. If your house went up in value when you were not living in it; for example, when you used the property as a rental house, you cannot exclude gain from the time you rented it out. For determining the amount of the gain you cannot exclude, the property is assumed to have gone up in value evenly over the period of time you owed it.
    8. You don’t have to buy a home of greater value, or any other home, to exclude this gain.
      There are no longer any requirements to buy another home after you sell in order to exclude the gain from the sale of your home.
    9. Long-term capital gains rates are lower than the ordinary tax rates you pay on short-term gains. Long-term capital gains tax rates for 2017 are 0%, 15%, or 20%, depending on your income tax bracket. Ordinary income tax rates for 2017 range from 10% to 39.6%. High-income taxpayers must pay an additional 3.8% tax on Net Investment Income (NIIT), including any gain from the sale of a residence that is not excluded from income. For this purpose, a high-income taxpayer is a taxpayer with a Modified Adjusted Gross Income (MAGI) of more than $200,000 ($250,000 if married filing jointly or a qualifying widow(er), $125,000 if married filing separately).
    10. When you sell your home and move, be sure to update your address with the IRS and the U.S. Postal Service. File Form 8822 – Change of Address, to notify the IRS.
    11. Most Importantly——>If you are selling your home (or are just thinking about it) contact Solid Tax Solutions and let us help you: (845) 344-1040.

    Hey, if you like this article let us know and also take the time to look at some of the other helpful articles here at The Tax Nook and please feel free to share our blog with your family and friends.

    Until the next time….

    _________________________________________________________________________________________________

    Bruce – Your Host at The Tax Nook

    Our Firm’s Website: SolidTaxSolutions.com (or just click on the icon on right sidebar of this page).

    Other Social Media Outlets: Facebook.com/SolidTaxSolutions (or just click on the icon on right sidebar of this page).

    Twitter: Twitter.com/@SolidTax1040 (BTW, We Follow-Back).

    Do You Need to ‘Timely’ Send Out Your Tax Return?

    Hi all! For those of you who want to send tax returns to the IRS by Private Delivery Service (i.e., don’t or can’t e-file) but wonder if the tax return will reach the IRS in a ‘timely’ manner and can you use just any ole’ PDS……well the answers are right below.

    In most cases the IRS considers ‘timely mailing as timely filing’. That is, if the tax return, payment, election, etc. is mailed on or before the due date, the IRS considers it filed on time, regardless of when it arrives. Prior to 1997, this rule only applied to the U.S. Postal Service. Thus, if you mailed your return by a private delivery service, the IRS considered it filed on time only if it arrived on time. Now, certain private delivery services are afforded the same status as the post office. The delivery services and the type of service are:

    The list of designated PDSs effective April 11, 2016 is as follows:

    DHL Express

    • DHL Express 9:00
    • DHL Express 10:30
    • DHL Express 12:00
    • DHL Express Worldwide
    • DHL Express Envelope
    • DHL Import Express 10:30
    • DHL Import Express 12:00
    • DHL Import Express Worldwide

    Federal Express (FedEx)

    • FedEx First Overnight
    • FedEx Priority Overnight
    • FedEx Standard Overnight
    • FedEx 2 Day
    • FedEx International Next Flight Out
    • FedEx International Priority
    • FedEx International First
    • FedEx International Economy

    United Parcel Service (UPS)

    • UPS Next Day Air Early AM
    • UPS Next Day Air
    • UPS Next Day Air Saver
    • UPS 2nd Day Air
    • UPS 2nd Day Air A.M.
    • UPS Worldwide Express Plus
    • UPS Worldwide Express

    FedEx and UPS are not designated with respect to any type of delivery service not identified above. Therefore, for UPS regular ground service doesn’t qualify.

    Notes:

    Only the services listed above for each carrier qualifies for this special rule. Other services provided by these carriers are not covered.

    You may still want to use the postal service. The rules for substantiating the “postmark” on private delivery services varies. Don’t forget, it’s not just the mailing but proving the date of mailing that counts. Check with the delivery service on their policy for the various types of delivery. Obtaining a proof of mailing from the U.S. Postal Service may be more convenient.

    In addition, just keep in mind that the rules for  the states vary. Check the individual state. For example, at least one state accepts delivery by the above carriers, but to a different address than if you’re sending the return or other item by U.S. Postal Service. And, as of the writing of this blog post, one state has not accepted the updated list.

    References:

    • Notice 2016-30
    • Notice 2015-38
    • Notice 2004-83
    • Notice 2002-62
    • Notice 2001-62
    • Notice 1998-47
    • Notice 1997-50
    • Rev. Proc. 97-26
    • Rev. Proc. 97-19

    ___________________________________________________________________________________________________

    Bruce – Your Host at The Tax Nook

    Our Firm’s Website: SolidTaxSolutions.com (or just click on the icon on right sidebar of this page).

    Other Social Media Outlets: Facebook.com/SolidTaxSolutions (or just click on the icon on right sidebar of this page).

    Twitter: Twitter.com/@SolidTax1040 (BTW, We Follow-Back).

    Categories: Tax Return Filing