If you’re an accountant who loses money, and your spouse is a real estate agent who makes money, can you combine your business with your spouse’s in order to calculate self-employment tax?
Not according to the Tax Court, which just held that a CPA husband’s unprofitable accounting business could not be combined with his wife’s realty business to net the income of the two businesses for self-employment tax purposes.
Brenda Fitch was a licensed real estate agent who worked full time as an independent contractor with Remax, while her husband Donald was a CPA who owned and operated an accounting practice. Brenda and Donald reported the income from their respective businesses on separate Schedule Cs.
The IRS separately computed the Fitches’ self-employment tax, determining that Brenda had net income from self-employment with respect to the realty business, while Donald’s self-employment tax was zero. (Donald was recovering from a medical problem and worked approximately four hours a day at his accounting practice during the years in question).
The Fitches combined the net income with respect to the realty business with the net losses with respect to the accounting practice in computing their self-employment tax, so that they had net losses.
The Fitches argued that the net income with respect to the realty business should be attributed solely to Donald because Brenda did not substantially manage and control the business. They said that Donald “collaborated and contributed to the management and control of the *** [realty business] in a multitude of ways.”
They cited Section 1402(a)(5)(A) of the Tax Code and Reg. Section 1.1402(a)-8(a) as authority for the proposition that income derived from a business in a community property state is treated the same as that of the husband for self-employment purposes unless the wife has exercised substantially all of the management and control of the business.
The IRS argued that the realty business was operated solely by Brenda, and thus the net income must be attributed to her alone. The IRS also noted that the Code section had been amended by the Social Security Protection Act of 2004 but that the regs cited by the Fitches had not yet been updated to reflect the amendment. Furthermore, the IRS said, the Fitches had executed a prenuptial agreement opting out of California’s community property laws.
The Tax Court noted that during testimony Brenda had referred to the realty business as “my business,” and Donald likewise had referred to it as “her business.” The court concluded that the realty business was not jointly operated by the couple, but was solely operated by Brenda. The self-employment tax therefore had to be calculated separately for Brenda and Donald, and could not be combined.
Would the result have been different if the testimony hadn’t referred to the realty business as Brenda’s business? “Probably not, but it didn’t help,” said tax attorney Barbara Weltman, author of J.K. Lasser’s Small Business Taxes.
”The question was whether his activities on behalf of her business made her business so interconnected with his as to allow the offset of the income. Clearly that wasn’t the case,” she said. “In fact, the law as we know it goes in the opposite direction, so that even spouses in a partnership in a single business have the opportunity to split the income appropriate to their ownership and each report their own share of the business income and self-employment separately. That way each gets to maximize their credits toward Social Security.”
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