You and Your Spouse Own a Business Together. What are the Tax Issues?
Ahhhhh……….The Husband and Wife owned business.
Love, love, love……….
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.
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.
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.
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
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