A husband and wife LLC will be taxed differently depending on the state where the LLC was formed.
How are husband and wife LLCs taxed?
It depends on the state where the husband and wife from the LLC.
If the LLC is formed in a non-community property state, the husband and wife LLC can only be taxed as a Partnership.
If the LLC is formed in a community property state, the husband and wife have 2 options:
- Partnership taxation
- Sole Proprietorship taxation (aka Qualified Joint Venture)
Partnership taxation for husband and wife LLCs
This is the default tax classification for Multi-Member LLCs.
This means the IRS treats the LLC as a Partnership for tax purposes.
The LLC needs to file a 1065 Partnership Return, which is an “informational return”. The LLC then issues K-1s to both spouses. This shows their share of the profits. From there, the spouses report their K-1s on their personal tax return.
Sole Proprietorship taxation for husband and wife LLCs
Alternatively, spouses can make a special election to have their LLC taxed as a Sole Proprietorship. This can only be done if the LLC is formed in a community property state (and the additional rules are met; see below).
This is more technically known by the IRS as a Qualified Joint Venture LLC. Said another way, a Qualified Joint Venture LLC is a:
- husband and wife LLC,
- that makes an election to be taxed as a Sole Proprietorship instead of Partnership, and
- is formed in a community property state.
Important: A husband and wife must file a joint tax return in order to be eligible for Qualified Joint Venture taxation.
Note: For federal tax purposes, the IRS recognizes all taxpayer marriages regardless of the spouses’ sex or gender, as long as their marriage is legally recognized under state law. This doesn’t include registered domestic partnerships, civil unions, and other similar relationships that aren’t recognized as a “marriage” by state law.
This means that married couples of any sex or gender may pursue a Qualified Joint Venture LLC in a community property state (if the state recognizes their union as being a legal marriage).
What US states are community property states?
There are 9 community property states in the US:
- Arizona
- California
- Idaho
- Louisiana
- Nevada
- New Mexico
- Texas (related: how to start an LLC in Texas)
- Washington
- Wisconsin
What is community property?
Community property is property owned or shared between 2 spouses.
Community property is generally defined as property that you, your spouse, or both come to own during your marriage (while your primary home is in a community property state).
It can also be separate property owned by either party before marriage or moving into a community property state that both of you agreed to convert into community property.
Additionally, it may include any property that can’t be clearly determined to belong to one spouse or the other.
Is an LLC community property?
An LLC is community property if:
- The LLC was formed in a community property state
- The 2 spouses are the only LLC Members
- Both spouses participate in the business, and
- The spouses file a joint return
Source: IRS: Revenue Procedure 2002-69
What can a husband and wife LLC do in a non-community property state?
Simply put, if a husband and wife LLC is in a non-community property state, they must form a Multi-Member LLC. And the LLC will be taxed as a Partnership by default.
Alternatively, they can elect to have their LLC taxed as a Corporation. The 2 options are:
Said another way, a husband and wife LLC can’t be taxed as a Sole Proprietorship in non-community property states. And the LLC can’t be a Single-Member LLC.
References
IRS: Publication 555
IRS: Married Couples in Business
IRS: Revenue Procedure 2002-69
IRS: Election for Married Couples Unincorporated Businesses
IRS: Can a married couple operate a business as a sole proprietorship or do they need to be a partnership
Matt holds a Bachelor's Degree in business from Drexel University with a concentration in business law. He performs extensive research and analysis to convert state laws into simple instructions anyone can follow to form their LLC - all for free! Read more about Matt Horwitz and LLC University.
Hi Matt, If I or my wife died today, we’d have about $12mil in real estate in CT with a basis of about $5mil. 1/2 would get a step up in basis. Can we form an LLC in a community property state to hold the real estate so the surviving spouse gets a step up on 100% of the property?
Thanks, Mike
Hi Mike & Bev, unfortunately no, that strategy doesn’t work the way most people hope. Community property status is based on where you and your wife live (your domicile), not where the LLC is formed. So forming an LLC in a community property state (ex: Texas or Arizona) wouldn’t convert Connecticut real estate owned by Connecticut residents into community property. The double step-up in basis only applies to property that’s actually community property under the law that governs your marriage.
That said, a few states (ex: Alaska, Tennessee, and Florida) offer opt-in “Community Property Trusts” that attorneys sometimes use for this exact goal. However, whether the IRS honors the 100% step-up for couples who don’t live in those states isn’t fully settled, so it carries some risk.
Given the real estate value, I recommend working with an asset protection and estate planning attorney, along with an accountant. They can also weigh the Connecticut estate tax side, which matters at that asset level. Hope that helps!
Is it unusual that state law so severely affects federal taxes?
Thanks again,
Mike
Hi Mike, no, it’s not unusual. It’s one of the foundational ways our whole tax system works: the federal government generally doesn’t create property rights, it taxes the property rights that state law creates. In other words, the states decide what you own and how you own it, and the IRS just applies the federal tax treatment on top of that.
For example, whether you’re even considered married (and can file a joint return) is decided by state law. Whether property is community or separate, or held in joint tenancy or tenancy by the entirety, is state law too. Even your LLC only exists because a state created it, and the IRS then decides how to tax it. The community property step-up is another example.
The reason it’s built this way is that property, marriage, and inheritance have always been handled at the state level, so federal tax law piggybacks on those state-defined rights instead of building a separate federal version. That’s exactly why something like your domicile, which is a state-law question, can swing the federal tax result. Hope that helps!
My husband moved from Wisconsin to state of Washington. In order not to pay child support and family court sanctions. He put his $1,000,000+ house in an LLC with only his new wife as ownership. He payed cash for the house. How can I get the Wisconsin court orders unforced? I am the father of Katie Flood, former wife.
Hello, I’m not sure about this, as it’s outside the scope of work we do. You’d likely want to speak to a divorce and/or asset protection attorney. Thank you for your understanding.
I am sole member of a single member llc. I live in Washington State, which is a community
property state and I am getting a divorce.
Is my income/ profit community property?
Hi Kathryn, I’m not sure about this. I would check with a divorce attorney. Thank you for your understanding.
If my husband an I file as a single member llc in a community property state will we both get the social security benefits or will the social security just go to one of us?
Hi Mandi, with a Qualified Joint Venture LLC, both of you will get social security and Medicare benefits.
Thanks so much. We are in WA (community state). Can my wife and I co-own an LLC and take the S-Corp election for IRS or does it need to be single member only (e.g. as a member) to get S-Corp election? S-Corp in something is a must for tax purposes. Thanks.
Hi Rajiv, you can have an LLC taxed as an S-Corp for a Single-Member LLC or a Multi-Member LLC. Said another way, yes, you can.