Monthly Tax Tips

Family business? Taxes can be complex for family members

If you own a family business, the IRS has specific rules for employment taxes for family members.

Social Security benefits

A spouse is considered an employee if there is an employer/employee type of relationship between the couple. If one spouse substantially controls management decisions in the business, and the other spouse is under the direction and control of the first spouse, then the second spouse is an employee subject to income tax and FICA (Social Security and Medicare) withholding.

But, if the second spouse has an equal say in management, provides substantially equal services and contributes capital to the business, then a partnership exists, and the business' income should be reported on Form 1065, U.S. Return of Partnership Income.

Both spouses carrying on the trade or business

If the business is not a partnership, but a joint venture in which the only members are a husband and wife filing a joint return, the business is not treated as a partnership for federal tax purposes. A qualified joint venture is a trade or business if:

The only members of the joint venture are a husband and wife
Both spouses materially participate in the trade or business
Both spouses elect to have the provision of the act apply

All items of income, gain, loss, deduction and credit are divided between the spouses per their respective interests in the business. Each spouse takes into account his or her respective share of these items as a sole proprietor and accounts for his or her share on Schedule C. To determine net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account.

This generally does not increase the total tax on the return, but it does give each spouse credit for Social Security earnings on which retirement benefits are based, as long as neither spouse exceeds the Social Security tax limitation.

One spouse employed by another

If your spouse is your employee, not your partner, you must pay Social Security and Medicare taxes for him or her. The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and Social Security and Medicare taxes but not to FUTA tax. For more information, refer to IRS Publication 15, Circular E, Employer Tax Guide.

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