Optimal Forms of Company Ownership for Spouses from Taxation Point of View

Going into business together with your spouse can be an interesting idea to consider. You live together, you know each other very well and you understand each other perfectly. These qualities can be invaluable if you start a joint business venture. On the other hand, statistics show that a large portion of marriages in western countries end up in divorces. Thus, if you are thinking of starting a business company with your husband or wife, you have to account for this possibility in this or that way.

You have to think ahead and find the answers to several questions. What will happen if one of you wants to quit the company? What will happen if one of you wants to quit the family? What will happen when one of you dies? These are important issues to consider beforehand if you would like to go into business with your spouse.

Company structure for spouses

Below we discuss the company ownership structures available to married couples. We refer to the opportunities found in the USA for the sake of simplicity. Many other countries of the world offer similar conditions to their married citizens forming business companies even though some national legislations can be a bit different.

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Forms of company ownership suitable for spouses

The choice of your prospective company structure will determine how much you will have to pay in taxes to a large degree. Besides, different forms of company ownership bring different levels of protection of your personal assets. Finally, some types of companies can be set up in a fast and inexpensive way, while registering other types of companies is going to take more time and money. 

The IRS in the USA provides the following four opportunities to spouses wishing to start a joint company. You can register your company as:

  1. A Sole Proprietorship;
  2. A Partnership;
  3. A Limited Liability Company (LLC); or
  4. A Corporation.

The first two forms of company ownership are the simplest in terms of time and money required to set them up. If you would like to open an LLC or start a Corporation, you have to be prepared for a longer and more expensive process of company registration.

Let us take it for granted that you plan to do business in cooperation with your spouse and see what opportunities you have if you opt for one of the company structures mentioned above. Generally speaking, all company structures have their advantages and disadvantages and you have to do the math and some risk assessment when deciding what form of company ownership you want to choose.

Family company in the form of a Sole Proprietorship

A Sole Proprietorship is fast and simple to start and the reporting isn’t complicated at all. The biggest disadvantage that this form of company ownership has is the unlimited liability of the sole proprietor. If you take a loan for business purposes and you are unable to pay it back, you are answerable for the debt by all your property including your personal possessions. And since the property of a married couple is considered common property, your spouse becomes answerable by his/ her personal possessions for the other spouse’s business debts as well. (Unless they have put their personal property in a trust.)

How can you cooperate with your spouse if you register a Sole Proprietorship? One option that you have is hiring your spouse as a salaried employee. In this case, he/ she will have to pay the personal income tax on his/ her salary, but you can count the salary towards your business expenses, which will lower the amount of tax payable by you.

Another option that you have is somewhat peculiar. The word ‘sole’ means ‘single’, or ‘one’ but the US legislation as well as the legislations of many other countries allows registering a Sole Proprietorship in the names of two persons. This is possible if and only if these persons are husband and wife. That is to say, father and son cannot register a joint Sole Proprietorship by law while husband and wife can.

Normally, the company ownership is equally divided between spouses for legal purposes if they form a joint Sole Proprietorship. Theoretically, the spouses can make a written agreement and distribute the company ownership shares in a different way.

If you have a joint Sole Proprietorship with your spouse, things become intricate in case of divorce. Your company will have to cease to exist if you divorce your spouse. Only husband and wife are entitled to form a joint Sole Proprietorship and when you cease to be husband and wife, you automatically lose the right to have this sort of company.

Due to the fact that legal issues are inevitably going to arise when the spouses have a joint Sole Proprietorship and they divorce, it is advisable to make a written document when setting up this type of company. The document has to specify what happens to the company in case the spouses divorce. In practice, Sole Proprietorships of this kind are liquidated (dissolved) BEFORE the divorce process is legally started.

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Family company in the form of a Partnership

Many married couples who wish to do business together choose to register Partnerships rather than Sole Proprietorships. Advantages of a Partnership include the ease of formation and ease of reporting (only one form needs to be submitted). Besides, Partnerships are pass-through entities, which means they pay no corporate tax. Each Partner is taxed on the income that he/ she obtains from the company operations.

Another important advantage that Partnerships boast is the opportunity to draw up a Partnership Agreement. The Agreement can specify each Partner’s rights and obligations as well as the shares of the commonly made income that each Partner is entitled to receive.

What can be even more important, however, is that the Partnership Agreement can spell out the conditions on which the Partnership can be dissolved and how ownership shares can be transferred from one partner to another or from a partner to a third person (an outsider). Besides, the Agreement can specify what happens if the Partners – a married couple – divorce. Please note that a Partnership does not have to be dissolved in case of divorce, unlike a Sole Proprietorship, but it can. Please also note, that the law does not require that you necessarily should make a Partnership Agreement when creating a Partnership. At the same time, here we go again: you don’t have to but you can and having one can help a lot in certain cases.

An important disadvantage that Partnerships have is unlimited liabilities of the Partners. This is, however, applicable only in the case of a General Partnership. It often happens that one of the spouses acts as the business initiator, the main driving force in the business venture and the other spouse agrees to help with carrying out business operations. In this case, you may consider the opportunity to register a Limited Partnership.

A Limited Partnership shall have one General Partner anyway and he or she is liable by all his/ her property including personal possessions. The Limited Partner, however, is liable only by the amount of his/ her contribution to the capital that was registered at the moment when the Partnership was created. So if you want to start a joint business project with your spouse and you are the one who’s come up with the business idea, you can set up a Limited Partnership acting as the General Partner yourself and making your spouse a Limited Partner in your Partnership. In this way, you will protect your spouse’s personal property from any encroachment on the part of your business creditors. A nice opportunity to consider indeed.

Please note that you have to apply for a Tax Identification Number in most countries if you want to form a Partnership. This form of company ownership is rather simple but it is a bit more complicated than a Sole Proprietorship anyway.

Family company in the form of an LLC

An LLC is similar to a Partnership in the sense that it is a pass-through entity too: no taxes are payable at the corporate level. At the same time, an LLC has one important advantage over a Partnership: it is a separate legal entity and the LLC owners’ liabilities are limited by the business property. Their personal property will remain intact in case the business goes bust.

There is very little difference between an LLC created by a married couple and an LLC created by two or more friends, for example. However, in some states, there is an opportunity that is available to married couples exclusively.

One person (or one business entity) can set up an LLC and in this case, it is referred to as a ‘Single Member LLC’. A married couple can be entitled to set up a single member LLC too, depending on the country. The company ownership shares are not distributed between the husband and the wife in this case. Instead, the married couple as a whole owns 100% of the company assets. Please note, however, that disagreements may arise in case of divorce if you opt for this type of company ownership structure.  

When an LLC is formed, an Operating Agreement needs to be made. The functions of the Operating Agreement are similar to the functions of the Partnership Agreement: it spells out ‘the rules of the game’. It would be wise to clearly indicate in the Operating Agreement how the company ownership is divided between the spouses if you want to create an LLC together with your husband or your wife. It would also be a good idea to hire an attorney who could help you draw up the Operating Agreement in a proper way. This will allow avoiding quarrels over business property distribution if you have to divorce your spouse.

By setting up an LLC, you are creating a separate legal entity and a new taxpayer. Naturally, you’ll have to acquire a tax identification number for your family LLC. Please also note that in some states of the USA, you have to hire a registration agent to form an LLC. In some other states, you can designate yourself (or yourselves) as a registration agent.

Because the LLC owners have limited liability, this form of company ownership can be especially attractive in case you are not sure if your prospective business is going to succeed or fail. If you are planning to enter a medium- or high-risk business area, having a limited liability company would be precious.

There is one more option to consider if you would like to do business together with your spouse and form an LLC for this purpose. You can register a Single Member LLC in your personal name and make your spouse a hired company officer. You can appoint him or her company Director, if you wish.

Family company in the form of a Corporation

Similarly to an LLC, a Corporation is a legal entity whose shareholders have limited liabilities and this is an important reason why you may want to establish a corporation to engage in business with your spouse. Both of you can be the corporation shareholders and you can distribute the shares between the two of you in any way you like.

Any group of people is entitled to form a corporation whether they are spouses or not. So, there is no difference in the procedures involved in creating a corporation whether you are creating one with your spouse or with a friend. The important thing to choose is how you want to be taxed: as a C Corp or as an S Corp.

The main drawback that the C Corp has is that it is taxed at two levels, both corporate and personal. The corporation pays taxes on the corporate income and then the shareholders pay taxes on their dividends. At the same time, a C Corporation is a very powerful fundraising instrument as it is free to issue and sell as much stock as it desires. Besides, this form of company ownership brings unlimited opportunities for growth. So if you are optimistic about the future of your business and especially if you hope that your company will go public one day, you should think about establishing a C Corp making yourself and your spouse the company shareholders.

The main advantage of an S Corp is that it is one more pass-through entity and the taxes are payable only at the personal level. What is especially attractive about the S Corporation is that its shareholders’ liabilities remain limited even notwithstanding the fact that they pay no corporate tax at all. However, more restrictions apply as to the types of stocks that an S Corp can issue and sell in comparison to a C Corp. Besides, the number of S Corp shareholders is limited but this should not bother you if you are planning to set up a corporation with your spouse and nobody else.

Whatever corporation type you choose, you have to be prepared for a long registration process. Even setting up an LLC is much less difficult than setting up a corporation. In addition, when registering a corporation, you have to pay several substantial fees. It makes sense to form a family corporation if you want your business to grow infinitely in the future.

Is your spouse a partner or an employee in your company?

When two spouses work together towards one business objective, the IRS has to understand whether they work as equal partners or one of the spouses acts as the employer of the other spouse. This is important for taxation purposes.

Thus, it may happen that you will have to show to the IRS officer if you equally divide the duties, the rights, and the decision-making powers between the two of you or one of you is the head of the company while the other one is a subordinate. Whatever the case, working together with your spouse on a shared business goal can be fun.

If you would like to set up a company with your spouse, please write to info@offshore-pro.info and we will help you make the right choice as far as the preferable company ownership structure is concerned.

What business structure is preferable for a married couple wishing to go into business together?

Husband and wife jointly own the property that they own and this can be the decisive factor in setting up a company together with your spouse. If you don’t have much to lose, the easiest type of company to set up is a Sole Proprietorship. If you want to protect your personal property from business creditors, you’d better set up a Limited Liability Company.

What is the difference between a General Partnership and a Limited Partnership?

In a General Partnership, all Partners have unlimited liabilities. In a Limited Partnership, there is only one Partner with an unlimited liability. Limited Partners (of which there can be several) have limited liabilities. At the same time, their decision-making powers are also limited.

What is the difference between a C Corp and an S Corp?

The two types of corporations are different along several lines. Probably, the most important difference between them is that a C Corp is taxable at two levels – the corporate and the personal one – while an S Corp is a pass-through business entity and its shareholders are taxed only once, namely, on their personal income from dividends.

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