i would strongly suggest that you discuss your situation with a tax pro in your state. you are saying that in your business you spouse does not materially participate. see below. The IRS would deem her an employee. not a partner or independent contractor. as an employee, your business would have to file payroll tax returns and pay in fica, medicare and withholding taxes for her. failure to do so time can result in substantial penalties.
even in a qualified joint venture both spouses must materially participate.
per the IRS
One spouse employed by another
If your spouse is your employee, not your partner, you must pay Social Security and Medicare taxes for him or her. The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and Social Security and Medicare taxes, but not to FUTA tax. For more information, refer to Publication 15, Circular E, Employer Tax Guide
Understanding Material Participation Tests
Material participation in an income-producing activity is, generally speaking, an activity that is regular, continuous, and substantial. Income-producing actions, in which the taxpayer materially participates is an active income or loss.
Types of Material Participation Tests
For any tax year, a taxpayer, or their spouse, qualifies as materially participating in a venture if they satisfy any one of the seven material participation tests.
Test one: Participation for more than 500 hours.
Test two: Activity that constituted all participation substantially.
Test three: Involvement for more than 100 hours and no less than the participation of any other individual.
Test four: Which is a significant participation activity, combined with all significant participation activities, for more than 500 hours. A significant participation activity is a business in which the taxpayer participates, without qualifying for any of the other six tests, for more than 100 hours.
Test five: Participation during any five of the preceding ten taxable years.
Test six: Which is a personal service activity for any three prior taxable years. Personal service activities are activities in which capital is not a material income-producing factor, such as health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting.
Test seven: Partaking for more than 100 hours and based on all the facts and circumstances, on a regular, continuous, and substantial basis.
