There are lots of real estate agents who team up with their spouses. This can be a great way to run a real estate business, but there are some important tax consequences of running a business with your spouse.
If You Do Nothing You're In a Partnership
First, you should understand that doing nothing about your business's tax status is not a good option. If you and your spouse run a business together as individual co-owners, you'll automatically be in a partnership for tax purposes. This is not so good because partnerships are required to file partnership tax returns (unless they elect to be taxed as a corporation and file corporate returns instead). Partnership taxation is generally considered to be the most complex area in all of tax law. Here is what you're supposed to do:
- complete and file Form 1065, Return of Partnership Income, reporting all the partnership's income, deductions, gains, and losses
- complete a Schedule K-1 for each partner-spouse showing his or her share of the partnership's income or loss
- transfer the Schedule K-1 information onto a Schedule E, Supplemental Income or Loss, for each spouse
- complete a Schedule SE for each spouse, listing his or her share of partnership income as self-employment income, and
- transfer the data from the individual schedules onto the joint Form 1040.
Obviously, this requires a lot of time and money--tax pros can charge $1,000 or more to prepare partnership returns.
Many married couples who are in partnerships together don't file partnership tax returns. Instead, they file in the easiest and simplest way possible: They treat the business like a sole proprietorship--a one-owner business--and file a single IRS Schedule C for the business in the name of one spouse. They also report their business's net profits on one IRS Schedule SE filed in the name of the proprietor-spouse, with Social Security and Medicare taxes paid for that spouse alone.
Filing this way is easy, but at any time the IRS or Social Security Administration could come along and determine that the spouse are 50-50 partners and reallocate their business income for self-employment tax purposes. This could end up costing additional Social Security taxes. Moreover, the business expenses of the spouse not listed as a sole proprietor in Schedule C could be lost as he or she would be neither an employee who incurred employee expenses nor an owner who incurred business expenses.
Fortunately, you have an easy alternative to being taxed as a partnership: make a qualified joint venture election.
Qualified Joint Venture Election
Spouses who jointly own and manage a business together can elect to be taxed as a “qualified joint venture” and treated as sole proprietors for tax purposes. To qualify as co-sole proprietors, the married couple must be the only owners of the business and they must both “materially participate” in the business—be involved with the business’s day-to-day operations on a regular, continuous, and substantial basis. Working more than 500 hours during the year meets this requirement.
A couple elects to be treated as a qualified joint venture by filing a joint tax return (IRS Form 1040). Each spouse files a separate Schedule C to report that spouse’s share of the business’s profits and losses, and a separate Schedule SE to report his or her share of self-employment tax. That way, each spouse gets credit for Social Security and Medicare coverage purposes.
If, as is usually the case, each spouse owns 50% of the business, they equally share the business income or loss on their individual Schedule Cs. The couple must also share any deductions and credits according to their individual ownership interest in the business. If the business has employees, either spouse may report and pay the employment taxes due on any wages paid to the employees. The employer-spouse must report taxes due using the Employer Identification Number (EIN) of the sole proprietorship.
For more information on tax issues for husband and wife real estate teams, refer to The Real Estate Agent's Tax Deduction Guide, by Stephen Fishman (Nolo).