On October 23, 2019, the IRS released guidance with respect to the tax treatment of family members that work together in a family business.
De Facto Partnership
I expect it’s fairly common for a couple to treat a family business, where no entity has been formed, as a sole proprietorship owned by one spouse, with the income showing up on the couple’s joint annual federal income tax return (i.e., Form 1040) on a single Schedule C.
Apparently, the IRS thinks so too. This week they decided to warn taxpayers that if both spouses help with the business and share the profit and loss, under relevant tax rules they may have a de facto partnership and therefore should actually be filing a partnership return on Form 1065.
The solution for avoiding a partnership tax return in this context is fairly easy and is referred to as making a “a qualified joint venture election.”
Qualified Joint Venture Election
As long as the business isn’t operated through an entity, the only partners are a married couple who files a joint return, and each spouse materially participates in the business, the couple may elect to not be treated as a partnership. This election is referred to as a qualified joint venture election and is made by simply having each spouse file a separate Schedule C with the joint federal income tax return, reporting such spouse’s share of income and deductions. Businesses owned through an LLC by spouses in a community property state can also choose to make this election by reporting their taxes this way.
Employment Taxes
The business will generally not need an EIN unless it must file excise, employment, alcohol, tobacco, or firearms returns. But if for example, the business has employees, then one of the spouses will need to obtain an EIN and should be designated as the party responsible for reporting and paying employment tax.
One spouse employed by another
The wages for the services of an individual who works for their spouse are subject to income tax withholding and Social Security and Medicare taxes but not to the Federal Unemployment Tax Act (FUTA).
Child employed by parents
Payments for the services of a child under age 18 aren’t subject to Social Security and Medicare taxes, if the business is a sole proprietorship or a partnership in which each partner is a parent of the child. Payments to a child under age 21 aren’t subject to FUTA. Payments are subject to income tax withholding, regardless of the child’s age.
Payments for the services of a child are subject to income tax withholding as well as Social Security, Medicare and FUTA taxes if they work for:
- A corporation, even if it’s controlled by the child’s parent, or
- A partnership, even if the child’s parent is a partner, unless the only partners are the child’s parents.
Parent employed by child
The wages for the services of a parent employed by their child are subject to income tax withholding and Social Security and Medicare taxes. They’re not subject to FUTA tax. The parent, like any employee, should complete a Form W-4 so that the correct amount of federal income tax can be withheld.
Mike Baker frequently advises with respect to family businesses. He possesses a breadth and depth of experience in tax and employee benefits & compensation law that spans multiple decades. For additional information, please contact mike@mbakertaxlaw.com.