For reasons not relevant here I and my wife are required to file separately this year. I own a couple Sch. C Sole Proprietor businesses in which I materially participate, but she does not. The businesses have inventory. We also have a prenup agreement that pretty much keep our income finances separate.
However, we are in California - a community property state. So my understanding is that in a community property we are required to allocate the Sch. C profits/losses 50/50 to each of us regardless, and whether we like it or not (we'd rather not).
Two questions:
1) Is that correct, or is there a way for me to put all the profit/loss on my own return?
2) It's easy enough to split all expenses and revenues, but how do you treat beginning and ending inventory counts? This is the 1st year she's filing a tax return in US and my businesses existed before that.
Do you I put each spouse's beginning of the year inventory as half of what it actually is (and same for year end)?
That would appear to create a contradiction with previous year's return - my 2021 beginning inventory would show as half of 2020 year end inventory.
And her new" business would appear to start with an inventory which came out of nothing.
That seems like an instant red flag for an audit for both of us.
Your prenup might be upheld against state law, but you need to consult with your attorney to confirm how it will be treated.
If it is upheld, you will file your Schedule C forms as you have in the past retaining all the income and property under your SSN.
If the business activities have to be split 50/50, you no longer have a Sole Proprietorship but actually have a Partnership. You will not report the business activities on a Schedule C after the split, but on a Partnership return, Form 1065. You will provide the K-1s from the return to yourself and your wife in order to report the income on your respective personal tax returns. The formation date of the Partnership will be the date the split became effective.
Thank you. But perhaps there is some confusion. Partnerships are treated completely differently. From everything else I'm reading, you still treat it as a Sole Proprietorship, but allocate all expenses/income 50/50 (except Self-Employment tax which all goes to one).
Example: https://ttlc.intuit.com/community/taxes/discussion/married-filing-separately-sole-proprietor-business-expenses-and-qbi/00/2554696
My only questions are if it's somehow optional and how to treat inventory.
You have a different situation because you have a prenup. You should not accept tax advice until you have confirmation from your attorney as to how the prenup effects your business.
The attorney who prepared it has previously stated that the prenup has no bearing on taxes.
Also all the IRS info seems to also make no mention of property separation, implying that its rules trump it in a community property state. Is that not the case?.
If that is the case, your statement in your first post that "We also have a prenup agreement that pretty much keep our income finances separate." is inaccurate because income has a direct impact on taxes.
If your attorney has advised that the prenup does not protect your business to be reported solely by you, then the information posted by @Thomas125 here is accurate for you too as well.
No, we really do have an prenup that pretty much keep all our finances separate. It's just that is applies to our peroneal internal accounting and property division in case of divorce, not necessarily taxes. You can't write a personal contract that overwrites tax law. I only mentioned it in case there was some way to use it as an option. Probably shouldn't have mentioned it not to detract.
But regardless, none of that addresses my actual two questions, especially the main one about the begin/end inventory handling.
Per IRS 2021 Instructions for Schedule C :
The above info is for a business co-owned by both spouses. If you own the business 100%, you should report all gross income and deductions on your Schedule C, including inventories, of course. You pay all the self-employment tax, and half of the net income is reported on your spouse's return.
2021 Instructions for Schedule C.
@Alik
OK. But doesn't that that part you marked in red about only one spouse reporting al of it if only they materially participated apply only n states which are NOT community states?
Isn't that why the community states are listed later on?
Very confusing language. Bottom line is - can I put it all on my own return only (filing separately), given that only I martially participated, EVEN THOUGH we are in a community state?
You will report the business return on your tax return, which incudes income, expenses, and inventories. Once you determine your net profit/net loss from the business, then you report the income/loss 50/50. This is a requirement that you must meet living in a community property state. Please read this IRS publication for additional information.
OK. So if I do only one Schedule C (on my own return), then after adding up all incomes and expenses it will result in the TOTAL income/loss. So then:
1) What form and line do I enter half of the income/loss into on my wife's taxes?
2) Likewise, how/where do I take off that half from my taxes wo we're not counting it twice?
I mean, I know you have to fill out form 8958 to show how you split the incomes, but it says: "Each of you must complete and attach Form 8958 to your return showing how you figured the amount you are reporting on your return. On the appropriate lines of your separate return, list only your share of the income and deductions on the appropriate lines of your separate tax returns (wages, interest, dividends, etc.). "
The questions is, what is that "appropriate line" in the case of a Sch. C income?
It can't be line 31 - Profit and Loss - on the Sch. C itself because that's a computed amount (from the rest of Sch. C) , not a simply entered one.
So how do I correct it to show only a half and where do I enter her half on her return?
Partnerships and single member LLC's are virtually taxed the same. You should begin preparing 1065's and just giving you and your spouse a k-1. The simplest way to record it this year, would be to split the activity in 2 schedule c's. If the problem is you cannot create 2 schedule c's with the same ein, then take the schedule c with the LLC name and your spouse will just use her name as a sole proprietor.
IT IS NOT A LLC OR A PARTNERSHIP! IT IS A SOLE PROPERIETOSHIP!
And you're completely contradicting DaveF1006's previous post which says to only fill out one Sch. C.
I don't know which is correct, but it's a direct contradiction.
Dave is right. When you go through your state return, it will ask questions since you are MFS in a community property state. During the questions, you will report the incomes for each of you and the program will handle it. You will need to give your wife the net income for her to use half on her return.
When you do the state return?
But that's only done after the federal is complete.
I am sorry! No, Dave is correct that your federal sch C is all under your name. You deserve the Social Security credit for working. Once you get done with your federal return and you go into the state, then it will ask you to start dividing up and filling in information.
It sounds like you need to override values and you may need to purchase the desktop version and use direct input. https://ttlc.intuit.com/community/taxes/discussion/can-i-efile-with-an-overridden-field/00/479332#:~:text=The%20TurboTax%20CD%2FDownload%20software,overridden%20values%20in%20your%20return.
Any professional tax software (not consumer software) can also override.
I would report all of the Sch-C's that you have on your return as normal (100% ownership), then override the community property allocation, override the total income, then review the results and search for more possible overrides. Include a disclosure statement form for your explanation.
For your wife, I would enter community property allocation amounts and that should be it. Since there are no overrides, don't worry about disclosure statements but include one anyways just for kicks.
The goal is just to report everything and pay all of the required SE tax and income tax. I normally recommend filing jointly to save on taxes and keep a community property return simple. I also recommend it for pending divorce cases as long as there is an agreement on how the refund or amount due will be split.