If you’re a married business owner and you want your business to be taxed as an S corporation, there are several things you need to know.
The difference between community property and co-ownership of an asset
Let’s take the example of owning a car. If you and your spouse are both on the title to a vehicle, you co-own the car. This means you may use the car, sell the car, or do anything you’d like with the vehicle. It also means you are both responsible for paying off any debt or liabilities that arise from the car. If one of you passes away, the survivor automatically becomes the car’s sole owner without needing additional actions.
But let’s say only one spouse has their name on the title. That spouse is the only owner of that car and is the only one (with certain exceptions) with rights and responsibilities attached to the vehicle. When the owner spouse dies, the car would have to be transferred to the surviving spouse via the estate plan or post-death or probate proceeding; it isn’t already owned by the other spouse like in the previous example.
However, vehicle ownership may look a little different depending on your state of residence. In many states, such as California, some rules make most assets acquired during the marriage “community property” of the married couple. In this situation, each spouse has rights to the property, no matter whose name is on the title. All assets considered community property are split up equally between the divorcing parties. In our car example, if the car is considered community property, it’ll be put into the big pot of community property and split evenly. That can cause either party to get the car and the other spouse to get something of equal value to offset it, splitting the ownership of the vehicle or the car being granted to both parties, but one buys out the other’s share. The main point of community property is that the parties get an even split for assets acquired during the marriage.
Community property rules apply to all assets owned by either spouse, including business ownership. Spouses can co-own shares of a business, and there may be legal and tax benefits. However, in the typical case of one spouse being involved with the company while the other is not, it rarely makes sense for the spouses to co-own the shares. If one spouse owns the claims individually, the other spouse may still have a community property interest, even if they’re not an owner.
How to fill out your Form 2553 S Corp Election
If your corporation or LLC is taxed as an S-corp, you must file Form 2553 with the Internal Revenue Service (IRS). The tax code states that anyone with a community interest in the stock must consent to the tax election, and Form 2553 asks for a list of all owners. If the business owner’s spouse has a community property interest, it seems he or she must be listed on the form. However, he or she is not an owner, so they shouldn’t be listed as an owner, right? Be warned, if you list your spouse as an owner of the business when they are not, there could be severe consequences later. So how do you comply with the conflicting rules?
The answer is to list your spouse in the shareholder section but note they are not shareholders. As you list the owners and their information, include your spouse, and get their signature. However, unlike the actual owners, you will list no ownership percentages, shares, or any dates those shares were acquired. Instead, you should note that the spouse is a “consenting spouse,” and perhaps they own 0% or zero shares of the business. This way, you satisfy both requirements: you are getting affirmative consent to the tax election, but you are not claiming that they are an owner when they are not.
Special considerations for professional corporations
If you are forming a professional corporation, properly completing Form 2553 is especially important. The rules governing professional corporations vary from state to state, but generally, the rules will dictate that only members of that profession may be company owners. For example, if you’re starting a professional veterinary corporation, only licensed veterinarians can be owners of the business (or may have to own a majority of the business). If a non-professional is an owner, the company’s status can be jeopardized, and you could lose your entire business entity.
It is of the utmost importance that you comply with the ownership requirements in your state to be considered a professional corporation. If you incorrectly complete Form 2553, you’re putting your entire entity at risk. So professional corporations, be warned: If you consider electing S-corp status, consult a professional. You are vulnerable if the form is filled out improperly. Problems are easier to prevent than solve!
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