(Note: When this article mentions the term “employment,” it means formal employment arrangements where a worker receives a Form W-2 at the end of the year, and therefore, as used in this article, does not include independent contractors that receive Forms 1099-MISC.
If you want to keep things in the family, and I suggest that everyone does, then you’re going to run into aspects of close ownership that have tax implications. These are best confronted head-on so that you can save as much money within the family unit. This article is specifically about businesses owned between two spouses and later goes into family businesses that employ family members.
A company owned by spouses
Spouses that jointly own a business might be in a formal partnership with each other, in which case the partnership would be on the hook for employment taxes for its employees’ wages. Those employment taxes are social security, Medicare, and the unemployment tax under the Federal Unemployment Tax Act (FUTA). Furthermore, if there is a partnership, the spouses would have to file a Form 1065, U.S. Return of Partnership Income on top of their normal personal federal tax return. This is due to the fact that the legal tax definition of a partnership is simply two or more people carrying on an enterprise, as owners, for profit, and as such this definition fits the bill of a spousal-owned business.
If spouses who jointly own a company do not want to be treated as a formal partnership for federal tax purposes, they can file as a qualified joint venture, which obviates the need to file a Form 1065 and transfers the burden of employment taxes to the spouses themselves, assuming their business employs individuals. The requirements for electing joint venture status are: a) the spouses are the only members of the joint venture; b) the spouses file a joint a return; c) both spouses work in the business (i.e. materially participate); d) both spouses voluntarily declare that they are not treated as a partnership for tax purposes; and e) the business is directly owned by the spouses and not incorporated as a limited liability company or corporation.
So what does a joint venture tax return look like? It’s simple; the spouses both file a separate Schedule C, Profit or Loss from Business, splitting all revenue and expenses equally between them. Furthermore, the spouses also each file a separate Schedule SE, Self-Employment Tax, which accounts for the self-employment tax, which is composed of social security and Medicare taxes. Finally, best practices dictate that if a company is jointly owned between spouses, then they should have an operating agreement that also declares that the spouses, who are the sole owners, have elected to file their return as a qualified joint venture.
As a final note on companies solely owned by two spouses, in community property states, such as Texas, you don’t have to elect to file your return as a qualified joint venture in order to get around having to file as a partnership. You can simply treat the company as a sole proprietorship owned by one of the spouses. In other words, file a joint return with one Schedule C and one Schedule SE, making sure that on the Schedule C, just one spouse is listed as the owner.
Family members as employees
If you employ family members, you will have to be concerned with four distinct types of taxes: the income tax, the social security tax, Medicare tax, and federal unemployment tax (FUTA). Depending on a) the types of services performed; b) the age of the person performing the job; and c) the ownership of the underlying company employing the family member, the family-owned company will be responsible for withholding some to all of these taxes.
First off, if you employ one or more of your children, as long as they’re under 18, and the company is wholly owned by you or you and your spouse, you have to withhold for income taxes, but not social security, Medicare, or unemployment taxes. If the child is over 18, and being paid for work in his or her parents’ business, assuming the business is completely owned by one or both parents, then the company is responsible for withholding income, social security, and Medicare taxes, but not federal unemployment taxes (FUTA). However, if the company employing the child is not entirely owned by one or both parents, like in the case of mixed parental and third party ownership, then income, social security, Medicare, and federal unemployment taxes would need to be withheld.
What if you employ your spouse? The answer is that you have to withhold for income taxes, social security, and Medicare, if you are the sole owner of the company. However, if you’re not the only owner of the company that employs your spouse, then you have to withhold for income, social security, Medicare, and federal unemployment (FUTA) taxes. The same would be true if the company that employs your spouse is a corporation, then all four taxes have to be withheld from wages, salaries, and tips, regardless of whether you are the corporation’s sole shareholder.
Finally, if you employ one or both of your parents, you have to withhold wages paid to them for income, social security, and Medicare taxes, if you own the company outright. However, if you are not the sole owner, meaning just one owner out of several, then you have to withhold for income, social security, Medicare, and federal unemployment (FUTA) taxes. The same goes for a corporation employing parents, even if you’re the sole shareholder; all four taxes have to be withheld.
If you are having problems making sense of how to file your taxes when you and your spouse own a company, or you can’t understand what taxes to withhold when you employ a family member, call Dino Tax Co today at (713) 397-4678 or email davie@dinotaxco.com. Your first phone consultation with us is always free. Also, don’t forget to like us on Facebook.
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