The Small Business and Work Opportunity Tax Act of 2007, signed into law on May 25, 2007, created a provision which changed the treatment of qualified joint ventures of married couples not treated as partnerships. The provision generally permits a qualified joint venture whose only members are spouses filing a joint return not to be treated as a partnership for Federal tax purposes. This provision is explained on the IRS website in the article Husband and Wife Business.
When a joint Schedule C (or Schedule F) is created in the program (by selecting that the responsibility for the operation of the business is equal between the taxpayer and spouse), there will be a Red Alert in the program regarding the Joint Business. The Red Alert is titled Error or Omission: Joint Business and states, If you and your spouse jointly own and operate a business and share in the profits and losses, the IRS considers this a partnership, whether or not you have a formal partnership agreement. Do not use Schedule C (Schedule F). Instead File Form 1065 - U.S. Return for Partnership Income. See IRS Publication 541 for additional information.
There will be two exceptions listed that may apply to your situation:
Exception 1. If you and your spouse wholly own an unincorporated business as community property under the community property laws of a state, foreign country, or U.S. possession, you may treat the business either as a sole proprietorship or a partnership. The only states with community property laws are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Note. If this is your situation, you may mark the Schedule C or F as equally owned and then ignore the Red Alert. You will be able to electronically file the return.
Exception 2. If you and your spouse materially participate in the business you may elect to not be treated as a partnership. Each spouse must file a separate Schedule C (or Schedule F) with the income and deductions divided based on your respective interests.