In business sickness and in business health
You’re married, and you want to run a business with your spouse. Congratulations!
But structuring your business is already complicated. With the added variable of a marriage, how do you make decisions about the way the business will be legally structured and run?
- Partnerships (1065) and S corps (1120S) provide the best combination of tax advantages, protection, and long-term stability for your business
- If you’re both actively working in the business, choose an S corp
- If only one of you is actively working, choose either a partnership or S corp
- SMLLCs and qualified joint ventures have early advantages, but they’re not ideal in the long run and leave you too vulnerable
Business structure options
Once you’ve decided to run a business with your spouse, it’s time to pick which business structure you’ll use and how you’ll pay taxes. Some of your options include:
- Sole proprietorship (Form 1040): A one-owner business that doesn’t include a legal identity separate from the owner. Income is reported on the owner’s individual Form 1040 tax return.
- Partnership (Form 1065): A type of business with two or more owners. The business reports income on its own Form 1065 tax return, but the taxes are paid by the individual owners.
- S corporation (Form 1120S): A type of corporation that reports income on its own Form 1120S tax return, but the taxes are paid by the individual owners (known as “shareholders” or “members”). It also avoids additional corporate income taxes.
Additionally, you can (and often should) form your business as a Limited Liability Corporation (LLC), a flexible type of business entity that can elect to be taxed as a sole proprietorship, partnership, s corp, or more. It combines this tax flexibility with excellent legal protection for its owners.
|📑Note: It’s a good idea to consider the effects this may have on the dynamic of your marriage, and how your marriage might affect the business. Whose name goes on which bits of paperwork? How will running a business together affect your relationship outside of work? What happens with the business if there’s a divorce? Make sure that you think over possible scenarios (including divorce, death, etc.) and have paperwork prepared in advance to address them. By an actual lawyer.|
Structures we recommend
We’ll cut to the chase: we nearly always recommend LLCs taxed as partnerships or S corps. The specifics will depend on whether or not you and your spouse both actively work in the business.
Both spouses work in the business
If you and your spouse plan not only on owning the business together, but both taking an active role in working there, an LLC taxed as an S corporation is your best bet.
S corp owners who work in the business are required to pay themselves reasonable compensation (essentially, a competitive wage for the job), but can also receive income in the form of distributions from the business. Crucially, these distributions are not subject to self-employment taxes, which can be significant.
One spouse works in the business
If only one of you takes an active role in running the business, you can pick between S corp and partnership.
The advantages of the S corp apply just as well with one active owner as two: splitting income between a reasonable wage and distributions means saving big on self-employment taxes.
In a partnership, only the active owner will be subject to self-employment taxes on their portion of the profit. Great! However, If the business loses money, only the active owner can take their losses as a tax deduction. The non-active partner will be able to carry those losses over to future years.
We ultimately recommend working with a good CPA to assess which of these options would be more advantageous for your unique situation.
Avoiding the audit risk of Schedule C
A key advantage shared by the S corp and partnership tax structures is that they avoid reporting the business’s income on your personal tax returns (which would be Schedule C on your Form 1040). This means that S corps and partnerships have a much lower risk of IRS audit, which can be stressful and expensive to navigate.
Structures we don’t recommend
It’s very common for small businesses to be run as sole proprietorships, or as Single Member LLCs (a one-owner LLC taxed as a sole proprietorship). We’re not into that.
Sole proprietorships and SMLLCs are both simpler to own and operate than partnerships and S corps, and don’t require the time and expense of filing a separate tax return for the business. This can make sense if the business is just a side gig that isn’t intended as the sole source of a living. But the disadvantages are significant.
When the business’s income is reported on your individual tax return, it opens you up to some massive risks. Mingling your personal and business finances like that mean that creditors, audits, lawsuits, and more can target you and your personal assets in addition to the assets of your business. An SMLLC provides some protection, but still usually leaves your personal and business finances dangerously intertwined.
What about a qualified joint venture?
A qualified joint venture is a unique type of business structure available only to married couples that allows them to be treated as one business owner. That means a married couple can run their family business as a sole proprietorship or SMLLC while owning it together.
This is intended to avoid the hassle and expense of an extra tax return while still recognizing both spouses as owners. However, this still leaves you open to the same vulnerabilities of a typical sole proprietorship, and we cannot recommend this option.
The safest move is filing a separate tax return for your business, and that means partnerships and S corps.
Going into business with your spouse is a big step, and the decisions you make early on can affect your success for years to come.
Setting your business up as an S corp or partnership can be more complicated up front, but the protection and stability this provides in the long term is more than worth it.
Need any help with that paperwork? Schedule a call with the experts at DiMercurio Advisors.