Q: I have a question that I’m very confused about, so I’ve included a link to a website that explains the idea. This seems like a legitimate company. They state that if a husband and wife run a business together in a jointly owned state, the IRS allows them to register as partners in a partnership or to report only on an IRS Self Employed Scheme C. You use an example where the company has an income of $ 250,000. In the case of civil partnerships, each spouse reports half of their income and pays a self-employment tax of 15.3% on their full share. This rate consists of a tax of 12.4% and a tax of 2.9%. If they report a Schedule C instead, the self-employment tax is greatly reduced, as the portion taxed at 12.4% reaches the legal limit. Can you confirm that this actually works?
A: I can’t. I don’t think the explanation is correct. I’ve checked the calculations and explanations in the link and you explain their approach in the same way as they do. I just think it’s wrong.
I will go through this step by step. The self-employment tax (SE) is levied on the self-employed. It is intended to replicate what an employee and his employer pay in wage taxes.
The wage tax is 6.2% for Old Age, Survivors’ and Disability Insurance (OASDI) and 1.45% for Medicare. Employers and employees each pay this total tax of 7.65% of the insured salary.
The OASDI tax is only levied on wages of $ 142,800. The Medicare tax applies to all wages. If one person has $ 250,000 in wages, the tax is lower than if two people had $ 125,000 each.
When a person is self-employed, they pay both the employer’s and employee’s share of the tax, which is the direct tax rate up to the OASDI limit of 15.3% and then 2.9%.
The IRS has stated that an unincorporated corporation owned by spouses as jointly owned may be reported as a partnership (two owners) or as an “disregarded corporation.”
If the choice is made to report as a disregarded company, all income will be reported on the appropriate tax form for the company’s business. If the company is running a business, a Schedule C would be the form.
At this point I agree with everything the article you attached in the link says. Where I believe they go wrong, assume that total income can hit the OASDI limit if there is no tax return for the partnership.
Section 1402 (a) (5) (A) of the Taxes Act addresses this point. There it says that the SE tax is due on the income of the spouse who practices this business if joint business assets are generated outside of a partnership.
The problem is that it persists and says that if both spouses continue to run the business, SE tax will be payable separately based on their respective distributing income shares of the business.
In the case of income tax, half of the operating income would be attributed to each spouse under common property law. Section 1402 contains a special regulation that only applies to the SE tax portion of the income.
The conclusion in your attached article only applies when there is only one spouse running the business. If both are involved, the income must be divided based on the respective shares each of them earns.
I will also note that Section 1402 (a) (5) (B) applies when a partner in a partnership is generating joint income. In addition, it only allocates the SE income to the shareholder who continues to run the company.
That is, if a wife is a partner in a New Mexico law firm, her share of the partnership income is her SE income alone. Your husband does not report half of the partnership income.
If the same wife ran her law firm as a sole proprietorship, the income would in turn be her SE income alone. In both cases, the SE tax issue is resolved by referring to who is generating the income, not by joint ownership.
You and I seem to be reading the suggestion of the article in the same way. Unless we overlook anything, the explanation is simply not correct.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected].
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