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 married couple is a partnership (and should file Form 1065, 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 married couple who file a joint tax return,
- The spouses own and operate the trade or business as co-owners (and not in the name of a state law entity such as an LLC or LLP),
- Both spouses materially participate in the trade or business, or maintain a farm as a rental business without materially participating (for self-employment tax purposes) in the operation or management of the farm, and
- Both spouses must elect qualified joint venture status on Form 1040, U.S. Individual Income Tax Return by dividing the items of income, gain, loss, deduction, credit, and expenses in accordance with their respective interests in such venture. Each spouse files with the Form 1040 a separate Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship), Schedule C-EZ (Form 1040), Net Profit From Business (Sole Proprietorship), Schedule F (Form 1040), Profit or Loss From Farming, or Form 4835, Farm Rental Income and Expenses, accordingly, and if required, a separate Schedule SE (Form 1040), Self-Employment Tax to pay self-employment tax.
For more information about the qualified joint venture rules, see Election for Married Couples Unincorporated Businesses.
Married couple 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 Revenue Procedure 2002-69 and the Instructions for Schedule C.
Partners in a partnership (including certain members of a limited liability company (LLC)) are considered to be self-employed, not employees, when performing services for the partnership.
- If you're a general partner of a partnership (or treated as a general partner in an LLC) that carries on a trade or business, your net earnings from self-employment include your distributive share of the income or loss from that trade or business. General partners must also include guaranteed payments as net earnings from self-employment.
- If you're a limited partner of a partnership (or treated as a limited partner in an LLC) that carries on a trade or business, only guaranteed payments for services you rendered to, or on behalf of, the partnership are net earnings from self-employment. Limited partners don't pay self-employment tax on their distributive share of partnership income, but do pay self-employment tax on guaranteed payments.
- If you're the sole owner of the LLC and the LLC has no employees, you won't need a separate federal tax ID number (EIN).
- If you're not the sole owner of the LLC, you'll need a separate federal tax ID number for the LLC.
- A new LLC with one owner (single-member LLC) that chooses to be taxed as a corporation or an S corporation will need a new federal tax ID number.
A domestic 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, the IRS will by default treat it as if it were a sole proprietorship (disregarded entity) unless the owner makes an election to have it treated as a corporation.
- Two or more owners, the IRS will by default treat it as a partnership unless the entity makes an election to have it treated as a corporation. Special rules exist for an LLC wholly owned by a married couple in a community property state, under which the LLC may be treated as a sole proprietorship (disregarded entity) notwithstanding that it has two owners; (See Revenue Procedure 2002-69 and Publication 541, Partnerships).
An LLC may elect a classification as a C corporation or an S corporation (assuming the LLC otherwise satisfies the requirements). Use Form 8832, Entity Classification Election to make an election to be a C corporation. Use Form 2553, Election by Small Business Corporation to make the election to be an S corporation. If a taxpayer doesn't file Form 8832 or Form 2553, the default classification will apply. Different classification rules may apply in certain situations for certain types of businesses, including: banks, insurance companies, and nonprofit organizations that are also organized as an LLC.
Note: If an LLC that is otherwise disregarded has employees, the law treats it as an entity separate from its owner for reporting and payment of employment taxes.
Partnerships and corporations have different standards for filing an information return or income tax return.
- A domestic partnership must file an information return, unless it neither receives gross income nor pays or incurs any amount treated as a deduction or credit for federal tax purposes.
- A foreign partnership generally must file an information return if:
- It has gross income effectively connected with the conduct of a trade or business within the United States,
- It has gross income derived from sources in the United States, or
- It or its U.S. partner is making an election, such as an election to amortize organization expenses.
Refer to the Instructions for Form 1065, U.S. Return of Partnership Income for exceptions to filing requirements.
- A domestic corporation (including a Subchapter S corporation) must file an income tax return whether it has taxable income or not, unless it's exempt from filing under section 501.
- A foreign corporation generally must file an income tax return if it:
- Engages in a trade or business in the United States, even if it has no income effectively connected with the conduct of a trade or business in the United States during the taxable year,
- Has income, gains or losses treated as if effectively connected with the conduct of a U.S. trade or business and subject to taxation under subtitle A of the Internal Revenue Code (relating to income taxes), or
- Doesn't engage in a trade or business in the United States at any time during the taxable year but has U.S. source income, and the withholding at source under Chapter 3 of the Internal Revenue Code didn't fully satisfy its taxation.
Refer to the Instructions for Form 1120-F, U.S. Income Tax Return of a Foreign Corporation for other reasons a foreign corporation must file a return and exceptions to filing requirements.
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
- Isn't a personal service corporation.
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.
Refer to Publication 542, Corporations for more information.
Personal Holding Company
A corporation will be considered a personal holding company if it meets both the Income Test and the Stock Ownership Test.
- The Income Test states that at least 60% of the corporation's adjusted ordinary gross income for the tax year is from certain dividends, interest, rent, royalties, and annuities.
- The Stock Ownership Test states that at any time during the last half of the tax year, 5 or fewer individuals must directly or indirectly own more than 50% in value of the corporation's outstanding stock.
Refer to the Instructions for Schedule PH (Form 1120), U.S. Personal Holding Company (PHC) Tax for more information and for a list of exceptions.
Personal Service Corporation
- Its principal activity is performing personal services during the "testing period."
- Its employee-owners substantially perform the services. A corporation meets this requirement if more than 20% of the corporation's compensation cost for performing personal services is for personal services its employee-owners perform during the testing period.
- Its employee-owners own more than 10% of the fair market value of its outstanding stock.
- Personal services include, but aren't limited to, any activity performed in the fields of 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.
Refer to Publication 542 for more information.
A corporation, or other business entity that elected to be treated as a corporation (by filing a Form 8832, Entity Classification Election), must use Form 2553, Election by a Small Business Corporation to make an S corporation election. A business entity treated as a corporation must meet certain tests to qualify to be an S corporation. To learn more, see the Instructions for Form 2553 and the Instructions for Form 1120S, U.S. Income Tax Return for an S Corporation.