Changing from Sole Proprietorship to Husband/Wife LLC in Community Property State (TEXAS)

[ahoffman565]

My wife's Sole Proprietorship switched to a husband/wife LLC beginning on January 1, 2022. We live in a community property state (Texas), so I believe we can file as a "Husband and Wife Qualified Joint Venture LLC" via a Schedule C along with our 1040 and NOT have to file as a partnership.  (If I'm understanding all of this correctly, we'd be filing the same method as we've done all along).  We did obtain a new EIN for this LLC.   Do we have to "Close" my wife's old sole proprietorship in Turbo Tax and "Open" our LLC to inform the IRS of this? If so, how do I do this?   I don't believe we have any assets we were depreciating.  We do however have an inventory and a personal vehicle that we were using for business purposes.

[PatriciaV]

Yes, according to the IRS (Rev. Proc. 2002-69, 2002-2 C.B. 831), if you treat your LLC as a disregarded entity, you may report this activity with Form 1040 Schedule C rather than filing a partnership return on Form 1065. As long as you file in this manner, you are informing the IRS of your election to be taxed as a disregarded entity rather than a partnership. 

Remember these requirements to remain a qualified entity:

• The business entity is owned solely by a married couple as community property under the laws of a state, a foreign country, or a possession of the United States;
• No person other than one or both spouses would be considered an owner for federal tax purposes; and
• The business entity is not treated as a corporation under Regs. Sec. 301.7701-2.

Any year when you fail this test, you must file as a partnership using Form 1065.

According to IRS Election for Married Couples Unincorporated Businesses, the EIN assigned to the LLC must remain with that entity in case you file Form 1065 in the future. In other words, do not use the EIN for the LLC on your joint Federal tax return.

Since you are continuing to report this activity as a disregarded entity, you do not need to close/dissolve the prior business.

[ahoffman565]

@PatriciaV   Thank you for the answer.  That's exactly what we were hoping for.  However, I do have a follow up question.  When I import the tax file from TY 2021 into the Turbo Tax software for TY 2022, do I simply edit the sole proprietor company to rename it and add the new EIN?

[KrisD15]

Any married couple in any state can set up a qualified joint venture. 

The requirements are:

• the only members of the joint venture are a married couple who file a joint tax return,
• both spouses materially participate in the trade or business,
• both spouses elect to have the provision apply,
• the business is co-owned by both spouses and
• isn't held in the name of a state law entity such as a partnership or limited liability company (LLC)

Source

What is your reason to want to have a Qualified Joint Venture? 

[ahoffman565]

@KrisD15 We actually didn't originally set out to run as a qualified joint venture.  However, in reading over the rules on LLC formation we ran across the provisions for couples living in community property states (such as Texas where we live) to allow them to run their multi-member LLC as a sole-member LLC as long as the rules about LLC ownership and material participation were met.  The ultimate benefit for us is that we can continue to enjoy the "benefits" of the LLC (certain legal separations from our business assets) without the hassle of splitting up all of the tax information and have to file as a partnership.

[PatriciaV]

Yes, you can change the name of the existing business but do not add the EIN. Reserve that tax id number for the future, in case you need to file as a partnership. Furthermore, if you add the EIN for the LLC, you might confuse the IRS (see my note above regarding this IRS article Election for Married Couples Unincorporated Businesses). 
@ahoffman565

[ahoffman565]

@PatriciaV  So your recommendation is to change the name of the business (denoting its an LLC), but still continue to use the SSN associated with the original sole proprietor?  (in this case that SSN was for my wife).  What about where it asks for the proprietor's name?  Can we use both our names?  Or would that further cause confusion for the IRS?

[PatriciaV]

Yes, enter the actual name of the company and assign it to your spouse. This will enter that taxpayer's name on Schedule C. Do not enter the EIN for the LLC, which will allow the taxpayer's SSN to be entered on Schedule C. These are the appropriate entries for your situation.

TurboTax does not offer the option to use both your names on Schedule C because in most cases this would not be acceptable (two owners would imply a partnership). But in your case, using one taxpayer as the proprietor is correct.