Tax Planning/sole proprietor with spouse
I've been a sole proprietor in California for many years. When I married my wife she had a full time job but she's no longer working and fortunately we don't need her income.
In the last few years she's been helping my business out more and more but typically only a few hours per week. I've been filing as a sole proprietor, married filing jointly. Are we now required to form a partnership or qualified joint venture?
Also, the IRS website says regarding the QJV:
"Married co-owners failing to file properly as a partnership may have been reporting on a Schedule C in the name of one spouse, so that only one spouse received credit for social security and Medicare coverage purposes. The election permits certain married co-owners to avoid filing partnership returns, provided that each spouse separately reports a share of all of the businesses’ items of income, gain, loss, deduction, and credit. Under the election, both spouses will receive credit for social security and Medicare coverage purposes."
What "credit" they are referring to -- do they mean the self-employment tax which goes into my wife's SS benefits?
I'm going to attempt to cover a few unasked questions also.
"Married Co-Owners". You started this business as a sole prop. Unless you have promised an ownership interest to your wife, she is not a co-owner.
Spouses credit for Social Security. "Credit" is a loose term here. These programs are not a savings plan. Dirty little Secret: Your Social Security Benefits are calculated on the top 20 quarters of your income career. Only 5 years. Not on the total amount paid. If you could choose, would you rather get the highest benefit for the lowest total contribution? Then be paid at the top of the chart for only the last 5 years before you (your wife) take social security and get paid very little or nothing until then. On the other side the Federal Government would like everyone to contribute as much as they can, as often as they can, whether it really benefits the individual or not.
You could make her a co-owner. That WON'T increase revenue, profitability, or function in the business. It WILL broaden the liability, increase the taxes, and complicate the management of the business. No upsides, lots of downsides.
I always like concrete, verifiable answers, that include specific data that shows actual results. I don't have your numbers, so I'm going to show you an example of the tax consequences.
Lets say you are generating $150,000 annual gross personal revenue, that gets attributed (because you are a sole prop) to your personal tax return and you are paying Self Employment tax along with your income taxes.
Self employment tax is the combined Social Security and Medicare. 100% of your personal revenue is subject to Medicare, but Social Security has a limit, and for 2013 that limit is at $113,700. That means that the last $36,300 is not subject to the 12.4% SS tax. Everything else, your Medicare, and Joint 1040 tax return taxes are the same on the $150,000.
You take whatever deductions you can get, and you pay your personal tax rates on the rest. All of that will remain the same if you move some portion of "Your" personal revenue to "Her" personal revenue. The ONLY thing that changes is the $36,300 that wasn't subject to Social Security tax for you, is now subject to the tax for her.
An extra $4500 in taxes.
But really there is a much bigger discussion to be had. Taxes are a part of it, but not, "how much more tax will I have to pay if I make this change", the discussion should be: What changes can I make that will have a positive impact on my business? Can I REDUCE my taxes, can I REDUCE my liability and my wife's liability, can I structure in a way that makes is a more manageable business? Is there a way that I can give my wife more than "a liability and less family income"?
You are a successful business owner hobbled by a decision you made before you were successful. It is time to break free of that mold.
You are successful, you should be doing your business like all of the most successful businesses do.
Give me a call.