Run a business with your spouse? You may encounter unique tax issues

Do you and your spouse together operate a profitable unincorporated small business? If so, you may face some challenging tax issues.

The partnership issue

An unincorporated business with your spouse is classified as a partnership for federal income tax purposes, unless you can avoid that treatment.

To avoid the requirement to file a partnership return, a husband and wife who jointly own and operate an unincorporated small business can elect to report the business income directly on their joint return by making a Qualified Joint Venture (QJV) election, provided both materially participate in the business and the business is not operated through a state law entity such as an LLC or partnership. With this election, each spouse reports their share of income and expenses on separate Schedules C (or E, for rental, or F, for farming) attached to their joint Form 1040, and each files a separate Schedule SE for self-employment tax purposes.

A husband and wife who have previously filed partnership returns (Form 1065) for a jointly owned unincorporated business can switch to a Qualified Joint Venture (QJV) election in a subsequent year, as long as they meet the QJV requirements. When the QJV election is made, the partnership is considered terminated at the end of the taxable year immediately preceding the year for which the QJV election takes effect. For the year of the election and going forward, the spouses report their respective shares of business income and expenses as sole proprietors on their joint return, using separate Schedules C, E, or F as appropriate. There is no requirement to amend prior-year partnership returns or file a final Form 1065 for the year the QJV election is made; the change is made simply by reporting as a QJV on the joint return for the effective year.

Additionally, in community property states, if the business is wholly owned by the spouses as community property, they may choose to report all the income on one spouse’s Schedule C, E, or F, or file as a partnership, depending on their preference.

If an annual partnership return is filed (Form 1065), each spouse must be issued a separate Schedules K-1, which allocates the partnership’s taxable income, deductions and credits between each spouse.

The self-employment tax issue

Self-employment (SE) tax is how the government collects Social Security and Medicare taxes from self-employed individuals. For 2025, the SE tax consists of 12.4% Social Security tax on the first $176,100 of net SE income plus 2.9% Medicare tax. Once your 2025 net SE income surpasses the $176,100 ceiling, the Social Security tax component of the SE tax ends. But the 2.9% Medicare tax component continues before increasing to 3.8% — because of the 0.9% additional Medicare tax — if the combined net SE income of a married joint-filing couple exceeds $250,000. (This doesn’t include investment income.)

Schedule SE is required to calculate the SE tax on each spouse’s share of the net SE income, whether reported on a partnership Schedule K-1 or directly on a Schedule C, E, or F.

Although the 15.3% SE tax can be significant, there is a deduction for half of the SE tax.

Here are three possible tax-saving solutions.

1. Use an IRS-approved method to minimize SE tax in a community property state

Under IRS guidance (Revenue Procedure 2002-69), there’s an exception to the general rule that spouse-run businesses are treated as partnerships. For federal tax purposes, you can treat an unincorporated spousal business in a community property state as a sole proprietorship operated by one of the spouses. By effectively allocating all the net SE income to the proprietor spouse, only the first $176,100 of net SE income is hit with the 12.4% Social Security tax.

2. Convert a spousal partnership into an S corporation and pay modest salaries

Converting the business to S corporation status may reduce Social Security and Medicare taxes. Although only the salaries paid are subject to Social Security and Medicare taxes, it’s important to pay reasonable compensation to owners.  It’s also important to note that S corps come with their own compliance obligations.

3. Disband your partnership and hire your spouse as an employee

You can disband the existing spousal partnership and start running the operation as a sole proprietorship operated by one spouse. Then hire the other spouse as an employee of the proprietorship. Pay that spouse a modest cash salary. You must withhold 7.65% from the salary to cover the employee-spouse’s share of the Social Security and Medicare taxes. The proprietorship must also pay 7.65% as the employer’s half of the taxes. However, because the employee-spouse’s salary is modest, the FICA tax will also be modest.

With this strategy, you file only one Schedule SE — for the spouse treated as the proprietor — with your joint tax return. That minimizes the SE tax because no more than $176,100 (for 2025) is exposed to the 12.4% Social Security portion of the SE tax.

Additional bonus: You may be able to provide certain employee benefits to your spouse, such as retirement contributions, which may provide more tax savings.

We can help identify appropriate tax-saving strategies.