Rev. date: 01/09/2013
Unless a business meets the requirements listed below to be a qualified joint venture, a sole proprietorship must be solely owned by one spouse, and the other spouse can work in the business as an employee. A business jointly owned and operated by a husband and wife is a partnership (and should file
Form 1065 (PDF),
U.S. Return of Partnership Income) unless the spouses qualify and elect to have the business be treated as a Qualified Joint Venture, or they operate their business in one of the nine community property
states.
A married couple who jointly own and operate a trade or business may choose for each spouse to be treated as a sole proprietor by electing to file as a “qualified joint venture.” Requirements for a qualified joint
venture:
- The only members in the joint venture are a husband and wife who file a joint tax
return,
- The trade or business is owned and operated by the spouses as co-owners (and not in the name of a state law entity such as an LLC or
LLP),
- The husband and wife must each materially participate in the trade or business,
and
- Both spouses must elect qualified joint venture status on
Form 1040
(PDF) by dividing the items of income, gain, loss, deduction, credit and
expenses in accordance with their respective interests in such venture and each
spouse filing with the Form 1040 a separate
Schedule C (Form 1040) (PDF),
Schedule C-EZ (Form 1040) (PDF), or
Form 4835 (PDF) accordingly, and, if required, a separate
Schedule SE (Form 1040) (PDF) to pay self-employment tax.
Husband and wife businesses in community property states may sometimes qualify to be treated similarly to a sole proprietorship. For
Special Rules for Spouses in Community States see
Rev. Proc. 2002-69 and the
Instructions for Schedule C (PDF).
Rev. date: 01/09/2013
A domestic limited liability company (LLC) is an entity:
- Formed under state law by filing articles of organization as an
LLC.
- Where none of the members of an LLC are personally liable for its
debts.
For federal income tax purposes, an LLC may be classified and taxed as a sole proprietorship (single member), partnership (multi member), or a corporation (single or multi
member).
Generally, if a domestic LLC has:
- Only one owner, it will automatically be treated as if it were a sole proprietorship (disregarded entity) unless an election is made for it to be treated as a corporation. Special rules exist for residents of community property states, where the Qualified Joint Venture rules may apply (as referenced in
Publication 541,
Partnerships).
- Two or more owners, it will automatically be treated as a partnership unless an election is made for it to be treated as a
corporation.
Either one of these entities may elect a classification as a standard corporation. This election is made using the
Form 8832 (PDF),
Entity Classification Election. If a taxpayer does not file Form 8832, the default classification will apply. Different classification rules may apply in certain situations, including: banks, insurance companies, and nonprofit organizations that are also organized as
LLCs.
Note:
For employment tax purposes, if an LLC that is otherwise disregarded has employees it will be treated as an entity separate from its owner for reporting and payment of employment
taxes.
Rev. date: 01/09/2013
Generally, a closely held corporation is a corporation that:
- Has more than 50% of the value of its outstanding stock owned (directly or indirectly) by 5 or fewer individuals at any time during the last half of the tax year;
and
- It is not a personal service corporation.
The definitions for the terms "directly or indirectly" and "individual" are in
Publication 542,
Corporations.
A closely held corporation is subject to additional limitations in the tax treatment of items such as passive activity losses, at-risk rules, and compensation paid to corporate
officers.
A personal holding company is:
- Defined in Internal Revenue Code section 542.
- A corporation will be considered a personal holding company if
both the Income Test and the Stock Ownership Test are met.
- The Income Test states that at least 60% of the corporation's adjusted ordinary gross income for the tax year is from dividends, interest, rent, royalties,and
annuities.
- The Stock Ownership Test states that at any time during the last half of the tax year, more than 50% in value of the corporation's outstanding stock is owned, directly or indirectly, by 5 or fewer
individuals.
A personal service corporation is a corporation where:
- Its principal activity is performing personal services during the “testing
period.”
- Its employee-owners substantially perform the services. This requirement is met if more than 20% of the corporation’s compensation cost for its activities of performing personal services is for personal services performed by employee-owners during the “testing
period.”
- Its employee-owners own more than 10% of the fair market value of its outstanding
stock.
- Examples may be accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law firms, and the performing
arts.
Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier
of:
A. The last day of its tax year, or
B. The last day of the calendar year in which its tax year
begins.
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