Married couples that jointly own a business often by default choose to treat the business as a partnership, which requires the business to file a partnership return. However, in many cases, treating the business as a partnership and filing partnership returns is optional. A recent Tax Court case highlights how a married couple's choice to treat their co-owned business as a partnership can work to their detriment.
Often, the default choice is to treat the business as a partnership and prepare a separate return for the business. This can be for a variety of reasons, including a desire to not report gross income on an individual return because of the potential increased audit risk, or to provide liability protection for the owners.
However, there are alternatives. If the business is unincorporated and both spouses materially participate in its operation, Sec. 761(f), added by the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28, allows the spouses to make an election to be a qualified joint venture, under which the business will not be treated as a partnership. Rather, the spouses are treated as maintaining two sole proprietorships for all federal tax purposes, including income tax and self-employment tax.
The treatment of a business as a qualified joint venture can have several beneficial results. The business does not have to file a partnership income tax return or comply with the recordkeeping requirements imposed on partnerships and their partners. As a qualified joint venture, a business will not be subject to potential penalties for failure to file partnership tax returns pursuant to Sec. 6698. Additionally, each spouse is credited for his or her share of the earnings for self-employment tax purposes, and therefore each is eligible to make a separate qualified retirement plan contribution.
The election to be a qualified joint venture is made by simply preparing and attaching separate Schedules C, Profit or Loss From Business, or Schedules F, Profit or Loss From Farming, and Schedules SE, Self-Employment Tax, for each spouse with a timely filed joint individual income tax return.
Alternatively, married couples living in community property states may also treat a co-owned business entity as a disregarded entity for federal tax purposes, pursuant to Rev. Proc. 2002-69. By electing this treatment, the owners are again relieved of the partnership tax return filing requirements of Sec. 6031.
The advantage of nonpartnership tax treatment was spelled out recently in Argosy Technologies, LLC, T.C. Memo. 2018-35. In Argosy Technologies, a limited liability company (LLC) was owned 50% each by a husband and wife. The IRS proposed a levy to collect the owners' unpaid income tax liabilities and imposed a penalty for failure to timely file against Argosy after it filed Forms 1065, U.S. Return of Partnership Income, for 2010 and 2011 after the due dates. The taxpayers petitioned the Tax Court and argued that they were actually a single-member LLC, not a partnership, and therefore were not required to have filed a partnership return.
The Tax Court held that since the LLC had represented itself as a partnership on its tax returns, it could not argue that it was another entity and disclaim its validity as a partnership. Had the partnership returns not been prepared and a qualified joint venture or disregarded-entity election been properly made, the partnership penalties would have been avoided.
For a detailed discussion of the issues in this area, see "Tax Practice & Procedures: Filing 'Optional' Partnership Return Costly" in the October 2018 issue of The Tax Adviser.
— Kevin R. Sell, CPA
The Tax Adviser is the AICPA's monthly journal of tax planning, trends, and techniques.
Also in the October issue:
- A look at recent developments in estate planning.
- An analysis of the five kinds of interest expense.
- A discussion of how tax reform could lead to the IRS's reorganization.
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