We filed the paperwork to start her business about 4 years ago. It's a graphic design business and she is the graphic designer. I offered to help with the management of the business but it's her business and she gets clients and does the work. I only create invoices through quickbooks. We never filed form 1065 but always operated as a single member LLC and filed schedule C. How can we change classification with the IRS? Will we have penalties for previous years?
1) When you set this up years ago, what did you do with the Secretary of State for your state of residence?
2) What is your state of residency?
3) Following up with question 1, was this set up as a single member LLC or multi-member LLC?
3) EIN confirmation letter notes filing Form 1065.
Does it state the ownership percentages? It should.
Here are my thoughts and comments:
- Based on the limited facts, it appears that you have a multi-member LLC. By default, this entity type is treated as a partnership for federal income tax purposes. Most states follow federal treatment.
- As a result of the assumption in comment 1, you should have been filing a form 1065. Not sure who provided assistance with the Articles of Organization, but the document seems to be incomplete as it should provide ownership by member. Since your document does not, not sure how the IRS would look at this; most likely 50/50.
- Since you have not filed a partnership tax return, the statute of limitations has not begun to start. So technically you could be looking at some pretty hefty penalties for failure to file. Currently the penalty is $200 per month per member (this amount changed a few years ago and not sure exactly when, but the change was not significantly less). In addition, the IRS could assess a penalty for failure to provide K-1's to the members.
- I am not sure what your intent was from the beginning, but you should call the Ohio Secretary of State Office and inquire about terminating the multi-member LLC as you really have been operating as a single member LLC.
- From a federal perspective, you appear to have always reported the correct income / loss, and if you file a joint tax return, the end income tax liability is correct. What is not correct in the past is the assessment of self-employment tax.
- Bottom line is you do have an issue, but possibly only because of a lack of understanding when organizing the entity. If your true intent was for this to be a single member LLC from the beginning, at least get this corrected at the state level. Then I would recommend you file an initial AND final blank form 1065. Include an attachment with the tax return that indicates that you erroneously set up a partnership when in fact the entity was intended to be a single member LLC. Send this return certified mail return receipt requested. This at least notifies the IRS of an error in original entity type and a return has been filed. Should this ever be questioned, you have a final return along with an attachment explaining the situation. If the IRS would ever assess a penalty, draft a letter explaining the situation; lack of understanding, confusion, income has always been reported, etc. and request that the penalties be abated since there was no intent to avoid or evade any income tax. Just a matter of confusion of entity type and reporting.