If you are a business owner and have your family members working with you, then you need to know about the tax treatment of your income and losses. As per the IRS, when you include a family member like your parents, spouse, or children in your business operations, then the way you treat your taxes also changes. In addition to this, some of the other employment rules also apply when you involve your family in your business.
Let us take a quick look at these tax treatments and employment rules to understand better how you need to file your federal income tax returns.
Spouses in the same business are business partners
Things change when you and your spouse are carrying on the same business and share the profits and losses therein. In this case, it does not matter if you both have a formal partnership agreement or not because the law automatically makes you both a partner in that business.
How do you file your taxes?
If you and your spouse are carrying out the same trade or business, then you would need to file your federal income tax using Form 1065. In this case, you are not required to report the income or losses made from your business on Schedule C of Form 1040 in the name of either of the spouse as a sole proprietor.
How can you treat your business?
You and your spouse have the freedom to decide how you want to treat your business. You can either treat it as a partnership or as a qualified joint venture. You can do this by making a qualified joint venture election.
What is a qualified joint venture?
To qualify as a joint venture, you and your spouse need to elect not to be treated as a partnership. Your business would qualify as a qualified joint venture if: –
- You and your spouse are the only members in the business and file a joint return.
- You and your spouse materially participate in the business.
- You and your spouse both elect not to treat your business as a partnership.
How can you qualify as a qualified joint venture
You and your spouse both can elect not to treat your business as a partnership. You can do this only if the business is owned by you, and both of you work as co-workers. You cannot elect your business as a qualified joint venture if it is established in the name of a state law entity like a partnership or a limited liability company.
How do you treat your taxes in case of a qualified joint venture?
If you and your spouse qualify your business as a qualified joint venture, then you would both be considered sole proprietors for all federal tax purposes. In this case, you would both need to file separate income tax returns declaring your income and losses on Schedule C, separately.
You would not be required to use your Employer Identification Number (EIN) unless your sole proprietorship needs to file excise, employment, alcohol, tobacco, or firearms returns.
Please note that neither of you or your spouse can use the EIN to file your federal income tax returns. The EIN shall specifically be used only in the above-mentioned cases or for partnership businesses. You can file your taxes using your EIN for any number of years when your business does not qualify as a qualified joint venture.
All about employment taxes
If you have more employees in your business then you would need to report and pay employment taxes. You must report and pay employment taxes using your EIN for sole proprietorship. In this case, you would be considered as the ‘successor employer’ for ensuring if wages match social security and federal employment wage limit base or not.
What happens when you hire your spouse?
If you hire your spouse as an employee in your business, then they would be subject to income tax withholdings and social security and medicare taxes. What your spouse would not be subject to Federal Employment Tax Act (FUTA).
What happens when you employ your children?
If yours is a sole proprietorship or partnership in which each partner is the parent of the child and the child is under 18 years of age, then the social security and medicare taxes would not apply. Also, payments to children below the age of 21 are not subject to Federal Employment Tax Act (FUTA). Please note that any payment made to your children as an employee of the business is subject to income tax withholdings no matter what their age.
The income paid to your children as an employee of your business will be subject to income tax withholding, social security and Medicare taxes, and FUTA taxes if: –
- They work for a corporation, even if it’s controlled by you or your spouse.
- The work for a partnership, even if it’s controlled by you or your spouse, but not by both as a partner.
What happens when you employ your parents?
If you employ your parents in your business, then the income paid to them would be subject to income tax withholding and social security and medicare taxes, but not to FUTA taxes.
You should make it a point to promote all your employees, related to you or not, to complete Form W-4 so that you can withhold the correct amount of withholding from the paychecks. You should promote them to use the Tax Withholding Estimator to ascertain the right amount of withholding to be deducted from their paychecks.
The Bottom Line
There are a number of changes in how you treat your taxes if you share a common business with your family members, be it as a partner or an employee. There are many other tidbits to keep in mind considering the nature of your business, i.e., a partnership or a qualified joint venture. What is important is that you are informed about all such tax codes in advance so that you can plan your taxes accordingly. In any case, to have a 360-degree view about the tax treatment in such cases, you can contact your MyTaxFiler expert and be on your way to make the most of your federal income tax returns.