Marital status can impact your S Corporation more than you may realize.
Before starting your business or changing its status, make sure you’re aware of all the implications this has for you and your spouse.
Community Property and Asset Co-Ownership
Community property is the designation given to any asset that a married couple owns together, regardless of the purchaser or name on the title or deed, in some states. Other states lean toward assets being either co-owned or solely owned by an individual. As an example, let’s consider how you and your spouse may own your vehicles.
If you and your spouse are both on the title to your vehicle, you co-own the car. You both have the right to use it, sell it or do whatever you’d like with the car. It also means you’re both equally responsible for paying it off and any liabilities that arise from the car. If one of you were to pass away, the surviving spouse automatically becomes the sole owner of that vehicle without taking any additional action.
But if only one spouse has his or her name on the title, then that spouse is the sole owner and has sole rights and responsibilities for that car. If the sole owner were to pass away, the car would have to be transferred to the surviving spouse based on the estate plan or any other post-death probate proceedings.
Some states, however, do not look at ownership of assets that way. California, among others, have rules that make most assets acquired during a marriage “community property” of both spouses. In this case, each spouse has rights to the property, regardless of the name on the title, deed, etc. In the case of a divorce, all assets are split evenly between the two parties. If the car is community property, it would be put into the “pot” of community property then split evenly by either giving the car to one party and the other party being granted something of equal value to offset, both parties splitting ownership of the car or the car being granted to both parties and one much buy out the other’s share. The point of community property is that each party has an even split of anything acquired during the marriage. But this rule doesn’t just apply to things like cars or houses.
These community property rules apply to all assets owned by either spouse, including a business. While spouses can co-own shares of a business, typically only one spouse is truly involved in the business and co-ownership of shares usually does not make sense. Alternatively, even if only one spouse owns the shares, the other spouse may still have a community property interest, even if they are not technically an owner of that business.
Spousal Designation on Your Form 2553 S Corp Election
If you decide to have your business taxed as an S Corp, you must file a 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 will ask for a list of all the business owners. If your spouse can claim community property interest, it seems logical that he or she should be listed on this form, right? But if they are not technically an owner, they shouldn’t be listed as an owner, right? So how do you comply with these conflicting ideas?
The answer isn’t obvious, but the correct way to do it is to list your spouse in the shareholder section of the form, but note that he or she is actually NOT a shareholder. Yes, that’s right – as you list all the owners and their information, include your spouse in this list and get his or her signature. The difference will be that unlike the actual owners, you will not list any ownership percentages or shares or any dates those shares were acquired next to your spouse’s name. Instead, you will note that he or she is a “consenting spouse,” and that he or she owns 0% shares of the business. Although a little convoluted, this solution satisfies both requirements of their affirmative consent without claiming any ownership where there is none.
Additional Considerations for Professional Corporations
The Form 2553 is especially important for professional corporations, as the rules dictate that only members of that particular profession may be owners of the company. For example, if you’re starting a professional dental practice corporation, only licensed dentists can be owners of the business. Having a non-professional owner can jeopardize the status of the company and could even cause you to lose your entire business entity.
As you can see, ownership requirements and the way your marriage impacts them can be complicated, but very important for the legitimacy of your business. If you are considering electing S Corporation status, make sure you consult with a professional business or tax attorney. Your business and your personal life can become quite vulnerable when these forms are filled out incorrectly or when you are not aware of its impact.