A common question asked by new married business owners is whether the spouse of the business owner should own an interest in the new limited liability company. And this is a great question.
I think, as a practical matter, you probably want to let personal feelings and marital health drive this decision. Telling your spouse–who is probably working hard to support you in the business–that you will be 100% owner of a new venture is probably not good marriage management. (Full disclosure: I’ve been married only once, am still married and I’m coming up on my 34th anniversary.)
However, while I am all for doing things that makes your husband or your wife happy, you should know this: Deciding to make your spouse the co-owner of your limited liability company may create some minor tax accounting headaches for you. And here’s why. An LLC owned by more than one person–a husband and wife, say–by default gets treated as a partnership for tax accounting purposes.
And that means the limited liability company will need to file a partnership tax return with the Internal Revenue Service and maybe also a partnership tax return with the equivalent state revenue agency. Filing a partnership tax return isn’t that big a deal… but partnership status does mean the expense and hassle of another tax return.
Let me also make this clarification, just so there’s not confusion. If you or your spouse operate a small business as a one-owner limited liability company, you don’t need to do anything particularly complicated to file your business limited liability company taxes. You just add a Schedule C form to your regular 1040 individual tax return.
Similarly, if you or your spouse own real estate through a one-owner limited liability company, you also don’t need to do anything complicated to file the real estate investment’s taxes. You just add a Schedule E form to your regular 1040 tax return.
Clearly, then, a hidden cost to bringing your wife or husband into your business or investment LLC is that you need to prepare or more likely need to pay some accountant to prepare a partnership tax return.
Let me make two qualifications here, however: First, if you and your spouse reside in a community property state and you guys own a two-member LLC, you may elect to treat your two-member LLC as a disregarded entity. This means you won’t have to treat the husband-and-wife limited liability company as a partnership. As mentioned in the preceding paragraphs, you’ll just report the limited liability company’s income and deductions on a Schedule C or on a Schedule E inside your individual 1040 tax return.
And here’s a second qualification about the “extra cost” of husband-and-wife limited liability companies. While most of the time treating a husband and wife LLC as a partnership just complicates and increases the costs of your tax accounting, in one special case partnership tax treatment saves you big money. Specifically, if a husband and wife treat a co-owned LLC which operates an active trade or business as partnership and one spouse works in a high wage job where he or she pays the maximum Social Security tax, a partnership tax return may save the family self-employment taxes. This occurs (or may occur) because any share of the partnership profit that’s assigned to that “employed-elsewhere” spouse won’t be subject to any Social Security taxes—only Medicare taxes.