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Business BriefsTax Briefs

Run a Business With Your Spouse? You May Encounter Unique Tax Issues

October 19, 2025by admin

Do you and your spouse together operate a profitable unincorporated small business? If so, you face some challenging tax issues.

The partnership issue

An unincorporated business with your spouse is classified as a partnership for federal income tax purposes, unless you can avoid that treatment. Otherwise, you must file an annual partnership return using Form 1065. In addition, you and your spouse must be issued separate Schedules K-1, which allocate the partnership’s taxable income, deductions and credits between the two of you. This is only the beginning of the unwelcome tax compliance tasks.

The self-employment tax issue

Self-employment (SE) tax is how the government collects Social Security and Medicare taxes from self-employed individuals. For 2025, the SE tax consists of 12.4% Social Security tax on the first $176,100 of net SE income plus 2.9% Medicare tax. Once your 2025 net SE income surpasses the $176,100 ceiling, the Social Security tax component of the SE tax ends. But the 2.9% Medicare tax component continues before increasing to 3.8% — because of the 0.9% additional Medicare tax — if the combined net SE income of a married joint-filing couple exceeds $250,000. (This doesn’t include investment income.)

With your joint Form 1040, you must include a Schedule SE to calculate SE tax on your share of the net SE income passed through to you by your spousal partnership. The return must also include a Schedule SE for your spouse to calculate the tax on your spouse’s share of net SE income passed through to him or her. This can significantly increase your SE tax liability.

For example, let’s say you and your spouse each have net 2025 SE income of $150,000 ($300,000 total) from your profitable 50/50 partnership business. The SE tax on your joint tax return is a whopping $45,900 ($150,000 × 15.3% × 2). That’s on top of regular federal income tax. (However, you do get an income deduction for half of the SE tax.)

Here are three possible tax-saving solutions.

1. Use an IRS-approved method to minimize SE tax in a community property state

Under IRS guidance (Revenue Procedure 2002-69), there’s an exception to the general rule that spouse-run businesses are treated as partnerships. For federal tax purposes, you can treat an unincorporated spousal business in a community property state as a sole proprietorship operated by one of the spouses. By effectively allocating all the net SE income to the proprietor spouse, only the first $176,100 of net SE income is hit with the 12.4% Social Security tax. That can cut your SE tax bill.

2. Convert a spousal partnership into an S corporation and pay modest salaries

If you and your unincorporated spousal business aren’t in a community property state, consider converting the business to S corp status to reduce Social Security and Medicare taxes. That way, only the salaries paid to you and your spouse get hit with the Social Security and Medicare tax, collectively called FICA tax. You can then pay reasonable, but not excessive, salaries to you and your spouse as shareholder-employees while paying out most or all remaining corporate cash flow to yourselves as FICA-tax-free cash distributions. Keep in mind that S corps come with their own compliance obligations.

3. Disband your partnership and hire your spouse as an employee

You can disband the existing spousal partnership and start running the operation as a sole proprietorship operated by one spouse. Then hire the other spouse as an employee of the proprietorship. Pay that spouse a modest cash salary. You must withhold 7.65% from the salary to cover the employee-spouse’s share of the Social Security and Medicare taxes. The proprietorship must also pay 7.65% as the employer’s half of the taxes. However, because the employee-spouse’s salary is modest, the FICA tax will also be modest.

With this strategy, you file only one Schedule SE — for the spouse treated as the proprietor — with your joint tax return. That minimizes the SE tax because no more than $176,100 (for 2025) is exposed to the 12.4% Social Security portion of the SE tax.

Additional bonus: You may be able to provide certain employee benefits to your spouse, such as retirement contributions, which may provide more tax savings.

We can help

Having a profitable unincorporated business with your spouse that’s classified as a partnership for federal income tax purposes can lead to compliance headaches and high SE tax bills. Work with us to identify appropriate tax-saving strategies.

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Business BriefsTax Briefs

Self-Employment Tax: A Refresher on How it Works

December 11, 2024by admin

If you own a growing, unincorporated small business, you may be concerned about high self-employment (SE) tax bills. The SE tax is how Social Security and Medicare taxes are collected from self-employed individuals like you.

SE tax basics

The maximum 15.3% SE tax rate hits the first $168,600 of your 2024 net SE income. The 15.3% rate is comprised of the 12.4% rate for the Social Security tax component plus the 2.9% rate for the Medicare tax component. For 2025, the maximum 15.3% SE tax rate will hit the first $176,100 of your net SE income.

Above those thresholds, the SE tax’s 12.4% Social Security tax component goes away, but the 2.9% Medicare tax component continues for all income.

How high can your SE tax bill go? Maybe a lot higher than you think. The real culprit is the 12.4% Social Security tax component of the SE tax, because the Social Security tax ceiling keeps getting higher every year.

To calculate your SE tax bill, take the taxable income from your self-employed activity or activities (usually from Schedule C of Form 1040) and multiply by 0.9235. The result is your net SE income. If it’s $168,600 or less for 2024, multiply the amount by 15.3% to get your SE tax. If the total is more than $168,600 for 2024, multiply $168,600 by 12.4% and the total amount by 2.9% and add the results. This is your SE tax.

Example: For 2024, you expect your sole proprietorship to generate net SE income of $200,000. Your SE tax bill will be $26,706 (12.4% × $168,600) + (2.9% × $200,000). That’s a lot!

Projected tax ceilings for 2026–2033

The current Social Security tax on your net SE income is expensive enough, but it will only worsen in future years. That’s because your business income will likely grow, and the Social Security tax ceiling will continue to increase based on annual inflation adjustments.

The latest Social Security Administration (SSA) projections (from May 2024) for the Social Security tax ceilings for 2026–2033 are:

  • 2026 – $181,800
  • 2027 – $188,100
  • 2028 – $195,900
  • 2029 – $204,000
  • 2030 – $213,600
  • 2031 – $222,900
  • 2032 – $232,500
  • 2033 – $242,700

Could these estimated ceilings get worse? Absolutely, because the SSA projections sometimes undershoot the actual final numbers. For instance, the 2025 ceiling was projected to be $174,900 just last May, but the final number turned out to be $176,100. But let’s say the projected numbers play out. If so, the 2033 SE tax hit on $242,700 of net SE income will be a whopping $37,133 (15.3% × $242,700).

Disconnect between tax ceiling and benefit increases

Don’t think that Social Security tax ceiling increases are linked to annual Social Security benefit increases. Common sense dictates that they should be connected, but they aren’t. For example, the 2024 Social Security tax ceiling is 5.24% higher than the 2023 ceiling, but benefits for Social Security recipients went up by only 3.2% in 2024 compared to 2023. The 2025 Social Security tax ceiling is 4.45% higher than the 2024 ceiling, but benefits are going up by only 2.5% for 2025 compared to 2024.

The reason is that different inflation measures are used for the two calculations. The increase in the Social Security tax ceiling is based on the increase in average wages, while the increase in benefits is based on a measure of general inflation.

S corporation strategy

While your SE tax bills can be high and will probably get even higher in future years, there may be potential ways to cut them to more manageable levels. For instance, you could start running your business as an S corporation. Then, you can pay yourself a reasonably modest salary while distributing most or all of the remaining corporate cash flow to yourself. That way, only your salary would be subject to Social Security and Medicare taxes. Contact us if you have questions or want more information about the SE tax and ways to manage it.

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Business BriefsTax Briefs

An S Corporation Could Cut Your Self-Employment Tax

May 25, 2021by admin

If your business is organized as a sole proprietorship or as a wholly owned limited liability company (LLC), you’re subject to both income tax and self-employment tax. There may be a way to cut your tax bill by conducting business as an S corporation.

Fundamentals of self-employment tax

The self-employment tax is imposed on 92.35% of self-employment income at a 12.4% rate for Social Security up to a certain maximum ($142,800 for 2021) and at a 2.9% rate for Medicare. No maximum tax limit applies to the Medicare tax. An additional 0.9% Medicare tax is imposed on income exceeding $250,000 for married couples ($125,000 for married persons filing separately) and $200,000 in all other cases.

What if you conduct your business as a partnership in which you’re a general partner? In that case, in addition to income tax, you’re subject to the self-employment tax on your distributive share of the partnership’s income. On the other hand, if you conduct your business as an S corporation, you’ll be subject to income tax, but not self-employment tax, on your share of the S corporation’s income.

An S corporation isn’t subject to tax at the corporate level. Instead, the corporation’s items of income, gain, loss and deduction are passed through to the shareholders. However, the income passed through to the shareholder isn’t treated as self-employment income. Thus, by using an S corporation, you may be able to avoid self-employment income tax.

Keep your salary “reasonable”

Be aware that the IRS requires that the S corporation pay you reasonable compensation for your services to the business. The compensation is treated as wages subject to employment tax (split evenly between the corporation and the employee), which is equivalent to the self-employment tax. If the S corporation doesn’t pay you reasonable compensation for your services, the IRS may treat a portion of the S corporation’s distributions to you as wages and impose Social Security taxes on the amount it considers wages.

There’s no simple formula regarding what’s considered reasonable compensation. Presumably, reasonable compensation is the amount that unrelated employers would pay for comparable services under similar circumstances. There are many factors that should be taken into account in making this determination.

Converting from a C corporation

There may be complications if you convert a C corporation to an S corporation. A “built-in gains tax” may apply when you dispose of appreciated assets held by the C corporation at the time of the conversion. However, there may be ways to minimize its impact.

Many factors to consider

Contact us if you’d like to discuss the factors involved in conducting your business as an S corporation, and how much the business should pay you as compensation.

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