Business Tax Policy: Compensation Allowance for Sole Proprietor Spouses
A second compensation allowance deduction may be available under the Business License Law and Business Income Tax Law to spouses who file a joint income tax return for both federal and state individual income tax purposes. When a joint filer (spouses) pays tax on the rental of jointly held rental property or a combination of property owned in each one’s name as separate property, each spouse is considered an owner and each spouse can claim a compensation allowance deduction.
Example 1: Kelly Smith and Eva Johnston are married and file joint federal and state income tax returns. Kelly owns a four-plex and Eva owns a commercial office rental in Portland. Since both Kelly and Eva meet the requirements of ownership and filing status, each qualify as an owner for the compensation allowance deduction.
Example 2: Frank and Chris Sparks file a joint return. Chris owns 12 residential dwelling units while Frank is employed as a stockbroker. Chris is the only owner for City and County tax purposes, and therefore, only one compensation allowance deduction is allowed.
In instances where one spouse owns a business and the other spouse works in the business, a second compensation allowance deduction may be allowed for both the Business License Law and the Business Income Tax Law in limited circumstances. If the non-owner spouse works more than half-time (1,000 hours per tax year), the non-owner spouse is also allowed a compensation allowance deduction. Any salary paid to the non-owner spouse is required to be added back to determine net income in this case. If the non-owner spouse works less than 1,000 hours, but that individual’s participation in the activity for the taxable year is not less than the participation in the activity of any other individual (including individuals who are not owners of interests in the activity) for such year, the non-owner spouse will be allowed a compensation allowance deduction.
Example 3: Sam Andrews is a part-time real estate appraiser. Sam’s spouse, Ann, works for Sam as a secretary/bookkeeper. Both Sam and Ann each work approximately 650 hours during the taxable year. There are no other employees in the business. Since no one else in the business participates to a greater extent than Ann does (not even Sam), Ann would be allowed a compensation deduction even though Ann works less than half-time.
Example 4: Faith Simpson owns and operates an art gallery in Portland and employs 11 full-time staff. Faith also owns commercial rental property. Faith’s spouse, Dan, works two days a week in the gallery as a salesman. Since Dan does not work more than half-time and since others in the gallery participate to a greater extent than Dan, Dan is not allowed a compensation allowance deduction.
4/18/17 Thomas Lannom
Date Director, Revenue Division
Revised 2009, 2017