When both spouses in a married couple are involved in the operation of an unincorporated business, it is fairly common– but incorrect – for all of that business’s income to be reported on one spouse’s Schedule C. In this case, the spouse not filing a Schedule C loses out on the chance to accumulate his or her own eligibility for Social Security benefits. In addition, to claim a child-care credit, both spouses on a joint return must have earned income (or imputed income if one of the spouses is a full-time student or is disabled), so unless the non-Schedule C spouse has another source of earned income, the couple will not be allowed a child-care credit.
There are ways to remedy this situation, however. One option is to file a partnership return for the activity, with each spouse receiving a K-1 for his or her share of the net profit. An approach that is probably less complicated is a qualified joint-venture election in which each spouse elects to file a separate Schedule C for his or her respective share of the business, giving them both self-employed income for the purposes of the self-employment tax and for claiming the child-care credit.
A qualified joint venture refers to any joint venture involving the conduct of a trade or business if:
(1) the only members of the joint venture are husband and wife,
(2) both spouses materially participate in the trade or business, and
(3) both spouses elect to apply this rule.
Generally, to meet the material participation requirement, each spouse will have to participate in the activity for 500 hours or more during the tax year (Code Section 761(f)(2)(B)).
OBSERVATION: If the net income from the business exceeds the annual cap on income subject to the Social Security tax, the combined self-employment tax for the spouses with split Schedule Cs will exceed what a single spouse would have paid if he or she had filed a single Schedule C. In addition, when filing split Schedule Cs, be aware of the different allocations of income for retirement plans and the opportunity for both spouses to participate in IRAs and self-employed retirement plans.