Your Sole Proprietorship and Your Spouse
Sole proprietorships can be the easiest and cheapest form of doing business, but things can get complicated if your spouse starts helping out. Sole proprietorships, by definition, can only be run by one person, so if you plan on having your spouse help out, here are some important things to consider.
Your Sole Proprietorship, Spouse and Filing a Joint Return
By definition, a sole proprietorship only has one owner, and the IRS will not recognize you as a sole proprietorship unless there is only one owner. However, filing a joint tax return with your spouse that includes the profits of your sole proprietorship will not convert it into a partnership. Although the IRS treats the income as belonging to you and your spouse, it still recognizes that only you own and run the business. On your joint tax return, you would list all of your business income on a Schedule C form.
Be careful when filling out your tax return to only list yourself on the Schedule C as well as any other business registration forms you file. This will make it clear to the IRS that, although the income is joint, the business is run solely by you. Anyone familiar with marriage property rights may find this odd, since legally, your spouse will typically co-own the company under your state's laws, but the IRS is a federal entity and can largely play by its own rules when classifying property and income.
Your Sole Proprietorship, Spouse and the Tax Consequences
As a business owner, you will typically owe employment taxes and have to withhold a certain portion of an employee's paycheck for tax purposes. If you plan on having your spouse occasionally volunteer for your business, you need to be extremely careful about what you allow them to do and how often they volunteer.
For example, if your spouse does any sort of advertising, contact with the public or signing of documents he or she may be holding him or herself out to the public as a co-owner of the business in the eyes of the IRS. If that happens, the IRS will hit you with back taxes and penalties, and any advantage you gained by running a sole proprietorship will be erased and then some. In addition, you may also owe back state and local taxes as well.
If you do end up using your spouse to help, even if only sporadically, consider creating an independent contractor agreement. Simply making an independent contractor agreement won't shield you from the IRS if you really are treating your spouse as a regular worker or co-owner, but it should be sufficient if your spouse is only occasionally helping out in a limited capacity.
Finally, be aware of the consequences to your spouse of either treating them as a volunteer or an independent contractor. First, as a volunteer, your spouse will not be earning credit towards their Social Security account, which requires a certain amount of work to be accomplished before he or she can benefit from Social Security. Second, as an independent contractor, your spouse will have to pay his or her own self-employment taxes since you will not be doing payroll taxes as if he or she were an employee.
Your Sole Proprietorship, Spouse and Equal Ownership
If your spouse wants any kind of say in your business or wants a specific share of your business' profits, then a sole proprietorship will not work. The second you break the cardinal rule of a sole proprietorship - that there is only one owner - you have created a different kind of business entity that requires specific documentation and which will be taxed differently. In other words, you cannot simply call a business a sole proprietorship, but run it as if it's a partnership or corporation. If you do, you will be heavily penalized by both the federal and state governments.
If the limitations of a sole proprietorship are proving to be too restrictive, consider forming another form of business that allows for more flexibility, but requires greater documentation and tax returns. Common forms of joint business ownership include partnerships, limited liability companies and corporations. Each of these have their own special advantages and disadvantages and may require registration of some sort with your state.
Even if you create one of these other forms of business, you can still run it as like a sole proprietorship with one spouse doing the majority of the work. This can reduce any future ambiguity and liability that may come with your spouse's status in a sole proprietorship, but still allow one spouse to primarily run the business.