Family Businesses as Sole Proprietorships

Although the sole proprietorship is, by definition, a single-owner business, many family businesses are operated in this form even though both spouses consider themselves to be the owners. However, it is important to be aware of the fact that the IRS considers the joint operation of a business by a husband and wife to be a "partnership" even if there is no formal partnership agreement. As a result, the IRS takes the position that a partnership return should be filed, rather than a Schedule C. You can use several strategies to avoid the necessity of filing a partnership return.

First, if one spouse is the primary business operator, then the business is a classic sole proprietorship. You can file as a sole proprietor, even if the other spouse fills in as needed or consults on major decisions.

If both spouses actively work in the business, you may consider one spouse to be the owner for IRS purposes, and the other may be considered an employee (or possibly even an independent contractor.) This will save you the time and trouble of filing partnership tax forms, and can generate additional deductions for the business.

Qualified joint venture. If you and your spouse each are active in the business and you file a joint return, you can elect to have the business treated as a qualified joint venture rather than as a partnership for tax purposes. Instead of filing Form 1065 (and issued yourselves Schedule K-1s reporting your shares of the income and expenses) you each file a Schedule C (or Schedule C-EZ) and report the income and deductions directly on your joint return. This election will continue to be in effect unless you receive the IRS's permission to change it or you no longer meet the conditions for making the election

You should be aware that under many state marital property laws, both spouses may be considered to be owners of the business assets in case of divorce, regardless of whose name is listed as the owner on the tax forms or the property records.

Work Smart Thanks to a 2007 law, the spouse of a sole proprietor will get credit toward Social Security taxes paid at the same level as the sole proprietor. Previously, the spouse had to file his or her own Schedule C or draw a paycheck to get credit, and this often meant many spouses weren't accumulating credits toward Social Security. Now, both spouses will get equal credit from a joint tax return.