I know single member LLC treated as pass-through tax status. But what about a husband and wife filing jointly. How do we file to get the pass through?

– Kelly, Missouri


Answer

The answer to this husband and wife LLC is complicated because the IRS has issued confusing guidance. Adding to the confusion there are different rules depending on whether married couple lives in a Community Property State (AZ, CA, ID, LA, NV, NM, TX, WA, & WI) as in those states there is a requirement that would allow disregarding the LLC partnership and the spouses would file as two sole proprietors on two Schedule C tax forms.

Here’s what the IRS says:

A spouse is considered an employee if there is an employer/employee type of relationship, i.e., the first spouse substantially controls the business in terms of management decisions and the second spouse is under the direction and control of the first spouse.

If such a relationship exists, then the second spouse is an employee subject to income tax and FICA (Social Security and Medicare) withholding.
However, if the second spouse has an equal say in the affairs of the business, provides substantially equal services to the business, and contributes capital to the business, then a partnership type of relationship exists and the business’s income should be reported on Form 1065, U.S. Return of Partnership Income (PDF).

http://www.irs.gov/businesses/small/article/0,,id=97732,00.html

    • In May 25, 2007 the Small Business and Work Opportunity Tax Act of 2007 was signed into law and affect changes to the treatment of qualified joint ventures of married couples not treated as partnerships. The provision is effective for taxable years beginning after December 31, 2006.
    • The provision generally permits a qualified joint venture whose only members are a husband and wife filing a joint return not to be treated as a partnership for Federal tax purposes. A qualified joint venture is a joint venture involving the conduct of a trade or business, if (1) the only members of the joint venture are a husband and wife, (2) both spouses materially participate in the trade or business, and (3) both spouses elect to have the provision apply.

In May 25, 2007 the Small Business and Work Opportunity Tax Act of 2007 was signed into law and affect changes to the treatment of qualified joint ventures of married couples not treated as partnerships. The provision is effective for taxable years beginning after December 31, 2006.

The provision generally permits a qualified joint venture whose only members are a husband and wife filing a joint return not to be treated as a partnership for Federal tax purposes. A qualified joint venture is a joint venture involving the conduct of a trade or business, if (1) the only members of the joint venture are a husband and wife, (2) both spouses materially participate in the trade or business, and (3) both spouses elect to have the provision apply.

Under the provision, a qualified joint venture conducted by a husband and wife who file a joint return is not treated as a partnership for Federal tax purposes. All items of income, gain, loss, deduction, and credit are divided between the spouses in accordance with their respective interests in the venture. Each spouse takes into account his or her respective share of these items as a sole proprietor. Thus, it is anticipated that each spouse would account for his or her respective share on the appropriate form, such as Schedule C.

The problem is, there is some dispute over what a “qualified joint venture” (QJV) is, and whether an LLC qualifies.

Some say that the distinction depends on whether you are in a community property state (in a community property state, a husband and wife LLC is a QJV).

Others think all LLCs owned by a husband and wife are QJVs and therefore qualify for schedule C treatment.

It is an unsettled area of law.

The default stance, it appears, is that an LLC with more than 1 member is a partnership and files a 1065 return. Part of the 1065 return is your K-1. The information from the K-1 goes onto your joint 1040.

 

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My Wife and I are going into business together

by Scott
(Ky)

My father owns a small counseling service (LLC) that my wife and are going to be taking over. How should we set this up? Should it be under one of our names and pay the other one a salary (1099) or should we go into it as a partnership? With that, how should we file our taxes under each scenario? Up to this point, we have always filed jointly.

-Thanks!

Answer

If the business is already a Limited Liability Company, then you and your wife would purchase the membership interests from your father.
If you both own the LLC, then, because you are husband and wife, you set up your LLC as a disregarded entity for pass-through taxation and would simply file your taxes on your joint 1040 return, Schedule C.

Record all your LLC’s income and expenses on your schedule C. You will then have to file self-employment taxes as well.

I recommend that if you don’t already have an accountant (and I mean a “real” accountant, not the guys with an H&R Block booth at Wal-Mart), then you ought to get a good small business tax package.

TurboTax Online has a special edition just for small business owners who use Schedule C, called the “Home and Business” edition.

As an LLC business entity owned by husband and wife, you will be filing like a single-member LLC / sole proprietorship using Schedule C.
If you’re not already using accounting software, get some. An old version Quickbooks can be picked on Ebay cheap. You need to keep track of all your income and expenses to take the maximum deduction you can and minimize taxes.

The other method is to have you own the LLC and then 1099 your wife. If you’re filing joint tax returns, I don’t see the advantage. You’re not going to avoid self-employment income tax, and you’re not going to avoid income tax. My initial read is that you, as a couple, will pay the same amount of taxes either way (though 1099ing your wife will involve more paperwork).

With the LLC owned by a married couple, there is better asset protection and protection from your personal creditors. If you were to be a single-member LLC and own the LLC 100% yourself, and you were sued personally, the creditor could take control of the LLC to satisfy the debt.

On the other hand, if the LLC is owned 50-50 between you and your wife, the best your creditor could do is get a charging order against the LLC, and your wife could freeze out the creditor from recovering any money by refusing to make payouts of profits.

Good luck with your new business!

 

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My husband and I just formed an LLC this year and have a question about filing as a disregarded entity.

by mel
(Kentucky)

My husband and I just formed an LLC this year and we are the only 2 members. I’ve read some of the answers and see that we can file on our schedule C as a disregarded entity but do we have to file for that status or fill out any additional forms prior to filing our schedule C with our personal tax return?

Being the first year- we are lost and don’t want to do something illegal by accident!!!

Thanks so much and your site has been such a help.

Answer

The IRS has issued confusing guidance on whether a husband and wife LLC can be a disregarded entity (Schedule C). There is some authority that the answer is:

1. Yes.
2. Yes if you’re in a community property state.
3. No.

You will not run afoul of the law filing a Form 1065 partnership tax return and issuing K-1s to yourself.

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