What is a Qualified Joint Venture and How Does it Work with Taxes?
What is a Qualified Joint Venture and how does it work? What are the benefits and drawbacks, and how to file taxes.
A “Qualified Joint Venture” (QJV) is a tax filing election and designation allowing married couples operating an unincorporated business to be taxed as a sole proprietor, rather than a traditional partnership. In its publication Election for Married Couples Unincorporated Businesses, the Internal Revenue Service (IRS) provides clear instruction. A qualified joint venture is a business venture conducting a trade or business where:
- There are only two members of the venture, a married couple filing a joint federal tax return.
- Both member spouses are engaged as material participants in the business.
- The spouses elect not to be taxed as a partnership.
To qualify, spouses, as co-owners, need to operate and participate in the business together. Although rules vary by state, if the business is a limited liability company (LLC), the members (spouses and co-owners), you won’t qualify for the qualified joint venture tax election status.
“Material participation” comes down to whether the individual “participated in the activity on a regular, continuous, and substantial basis during the year” and how much time the individual spent on activities in the business. The IRS provides additional guidance in Publication 925 Passive Activity and At-Risk Rules. In essense, both member spouses need to actively participate equally in the business.
Since 2007, the IRS
The IRS states in its publication Married Couples in Business, that a spouse can be considered an employee of the business and subject to income tax withholding if under the direct and substantial control of the other spouse as owner of the business. But if the second spouse has a substantial say in how the business operates and contributes capital to the business, then a partnership relationship exists. In the case of a partnership, the couple should report business income on Form 1065, U.S. Return of Partnership Income.
In hoping to avoid the paperwork, reporting requirements, and expenses of a partnership business, the IRS introduces the qualified joint venture.
Why Consider a Qualified Joint Venture for Your Business?
Based on the growing gig economy and freelancer market, many spouses are leaving their jobs and opting to start a home-based business together. Maybe you’re both consultants, writers, designers, run a dog breeding business, or want to open your own retail brick and mortar business. One of your first considerations should be how to structure your business in a way that keeps your tax liabilty as low as possible.
Before the IRS allowed a special election for qualified joint ventures, you and your spouse had to file as a partnership, multi-member LLC, or maybe you had an LLC but elected to file as an S-Corporation. Many still operate as sole proprietors with one of the owners filing a Schedule C on an individual tax return. The other spouse couldn’t report business income and contributions to Social Security and Medicare. In 2007, the IRS created the Qualified Joint Venture tax election allowing married couples working together in a business to file with lower costs and less paperwork than the other, existing choices. Another benefit of the QJV is that both spouses materially participating in operating the business split the business income and expenses into a Schedule C on each individual tax return.
Benefits of the Qualified Joint Venture
Spouses working together as co-owners operating a business gain at least a couple benefits by filing taxes as a joint venture:
It’s easy to file as a qualified joint venture:
Other filing options, such as filing as an LLC or Partnership, both carry a lot of extra paperwork and requirements. The most common choice is to file as a partnership, which requires:
- You must file to create your partnership.
- Annual documents are required to maintain a partnership.
- File and provide each partner with a Schedule K-1 (Form 1065) detailing their share of the income.
In contrast, you’re not required to file Schedule K-1 or 1065 Forms in a qualified joint venture.
Self-employment taxes for both spouses:
In a Partnership, the IRS considers one spouse as working in the business, while the other is not. Only one spouse is saving for retirement through Social Security self-employment taxes. Social Security benefits are computed based on how long you pay in and how much you pay in during your working years. With a qualified joint venture, you both can pay into Social Security to build your benefits.
How to File Taxes for a Qualified Joint Venture
Filing taxes for a qualified joint venture is not complicated. The IRS treats a qualified joint venture as two individual sole proprietorships. Each spouse files a Schedule C Profit or Loss from Business and a Schedule SE (Self-Employment Tax). They include both completed forms in their joint 1040 tax return.
Information for the Schedule C uses the business ownership/interest for each spouse. For example, let’s say you and your spouse have a consulting firm generating annual gross income of $300,000, expenses of $210,000, giving you a net income of $90,000. Based on the ownership percentage, you’d include the net income on each Schedule C:
- 50%/50% Split – Each spouse would enter income of $45,000 (50% of $90,000).
- 60%/40% Split – Spouse A income is $54,000 (60% of $90,000); Spouse B income is $36,000 (40% of $90,000).
It’s important to understand you’re not running the calculation on gross income – you should calculate on net income. The same ratios above apply to business tax deductions. The calculation begins with splitting up gross income based on the ratio, splitting expenses the same way, then calculating net income on each spouse’s Schedule C.
Are There Drawbacks in Filing as a Qualified Joint Venture?
Qualified joint ventures aren’t for everyone. You should carefully consider your individual circumtances and work with a tax professional. If you’re simply comparing benefits and drawbacks of a QRP vs. LLC vs. S-Corp, here are a couple things to concider:
- Liability – If you remember, an LLC can’t file taxes as a qualified joint venture. Filing as a qualified joint venture means you aren’t limiting your individual liability in your normal business operations. As a QJV, you assume all the individual liability and risk of sole proprietors or partnerships. Owners in sole proprietorships and partnerships are generally individually liable for judgements against or debts owed by the business.
- Taxes – as a qualified joint venture, both spouses are paying income and self-employment taxes on all the income passed through from the business. Filing as a corporation would allow some income to be subject to withholding taxes while some could be dividends and not subject to self-employment taxes.
When it comes to taxes, consulting with your tax advisor or accountant is never a bad idea.
More than ever before, married couples are starting businesses together or are getting married when working together in a business. If you fall into this group, sit down together and discuss your business and tax situation. Consult with your financial advisor, accountant, or a tax advisor. Consider the pros and cons of the current and future implications, including retirement.