UPDATED JANUARY, 2019 for Tax Year 2018
LLC owned by married couples with only the married couple as partners.
SUMMARY and then COMPLEX ANSWER follow
SUMMARY:
- If a married couple are the two (and only two) owners of a LLC, but if they do not live in a Community Property State =AZ, CA, ID, LA, NV, NM, TX, WA,
& WI - then they must file Form 1065 Partnership return first in order to produce the Schedules K-1 for each of the two partners.
- If a married couple are the two (and only two) owners of a LLC, and they live in a Community Property State =AZ, CA, ID, LA, NV, NM, TX, WA, & WI - and both participate materially in the business, then the following explantion provides the reason why the couple can avoid filing Form 1065 and instead file with their Form 1040 (joint presumably) and for each spouse produce a Schedule C and Schedule SE, simplifing the filing of taxes process. See below for how to account each spouses Schedule C and Schedule SE.
See shorter answers below if you undertstand the why you can or cannot file Schedule C and SE.
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Pardon the long-winded answer but it is a complex
matter.
See
the IRS instructions about dividing the items of income, gain, loss etc. - Your
wife must file within the joint 1040 as if there was second Sole Proprietorship
I'll
start with the IRS instructions that do allow you to elect to treat your SMLLC
as a disregarded entity, and then follow with a much more detailed
explanation. Whether you may or may not take the election
discussed is a matter of controversy in non-community property
states. Please see the discussion at the end.
Husband-Wife
- Qualified Joint Venture [for real estate ventures- see below]
http://www.irs.gov/instructions/i1040sc/ch01.html
NOTE WELL (N.B.): ====BUSINESS product is not needed!
Home & Business produces Schedule C - preferably the DESKTOP
Can a husband and wife, both residing in a Community Property state, run a business as a sole proprietor or do they need to be a partnership?
- If you and your spouse each materially participate (see Material participation, later, in the instructions for line G) as the only members of a jointly owned and operated business and you file a joint return for the tax year, you can accept the IRS' default designation of your LLC (owned by a married couple, only members, Community Property State residents) as a "disregarded entity." This means, that given the particulars as stated, your partnership status (the dual member LLC) is disregarded. The IRS designates your business as a Qualified Joint Venture. You both are treated as Sole Proprietors. If a married couple who file a joint tax return elect to conduct their business activities as a qualified joint venture, (a trade or business entity in which the husband and wife materially participate in such venture), the spouses must divide the items of income, gain, loss, deduction, credit and expenses in accordance with their respective interests in such venture. Of course, being in a community property state will obviously have an impact on distribution of the LLC membership interests in the event of a dissolution of the marriage.
- Alternatively, if a married couple, each participating materially, and being the only two partners in an LLC, and living in a Community Property State, may choose to be treated as a partnership with responsibility to file a Form 1065 for the LLC and then file their Form 1040 inclusive of the Schedule K-1(1065) each receives. This requires a prior election to be treated as a partnership for tax-filing purposes. Under IRS rules, you have to file the Form 8832 no later than 75 days after the date you want the new classification to take effect. So by March 15th of a year it is too late to so elect for the prior year. However, you can file your Form 8832 to elect to not be a disregarded entity status going forward. Attach a copy of your Form 8832 to your partnership tax return when you file it.
- It is possible for either the husband or the wife to be the owner of the sole proprietor business. When only one spouse is the owner, the other spouse can work in the business as an employee.
Please
note that there are discrepancies between various IRS publications as to the
matter of whether or not living in a Community Property State [e.g.,AZ, CA, ID,
LA, NV, NM, TX, WA, & WI] is a requirement that would allow
"disregarding" the LLC partnership and filing simply as two sole
proprietors on two Schedule C forms. However, the appropriate path is to assume that the three points above apply.
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How to account for dual Schedules C and SE
You must divide all items of income, gain, loss, deduction, and credit attributable to the business between you and your spouse in accordance with your respective interests in the venture. Each of you must file a separate Schedule C, C-EZ, or F. On each line of your separate Schedule C, C-EZ, or F, you must enter your share of the applicable income, deduction, or loss. Each of you must also file a separate Schedule SE to pay self-employment tax, as applicable.
For more information on qualified joint ventures, go to IRS.gov. Enter “qualified joint venture” in the search box and select “Election for Husband and Wife Unincorporated Businesses.”
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Commentary on whether
or not community property state residence is required may be found at the end of this answer - although it seems from the record of IR letters and other documents that it is required to so reside in order to file the LLC as a disregarded entity.
Alternatively, a couple may choose to be treated as a true partnership and file a Form 1065 if they make an
election to be taxed instead as a partnership.
This election, in most cases, will not increase the total tax owed on the joint
return, but it does give each of you credit for social security earnings on
which retirement benefits are based and for Medicare coverage. By making the
election, you will be required to file Form 1065 for any year the election
is in effect and will instead report the income and deductions directly on your
joint return. If you and your spouse filed a Form 1065 for the year prior to
the election, the partnership terminates at the end of the tax year immediately
preceding the year the election takes effect.
http://www.irs.gov/pub/irs-pdf/f8832.pdf
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Rental real estate business. If
you and your spouse make the election for your rental real estate business, you
must each report your share of income and deductions on Schedule E. Rental real
estate income generally is not included in net earnings from self-employment
subject to self-employment tax and generally is subject to the passive loss
limitation rules. Electing qualified joint venture status does not alter the
application of the self-employment tax or the passive loss limitation rules.
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COMPLEXITY AS TO RESIDENCY ISSUES:
The
issue of not living in Community Property states and LLCs owned jointly by, and
only by married spouses was simplified in theory in 2007 by Congress - yet as of this time (now 2019), the IRS only provides for the opportunity of electing LLC to be considered a disregarded entity to residents of Community Property states.
NOTE THAT THIS DISCUSSION IN 2007 HAS NOT BEEN FOLLOWED BY THE IRS. Starting
in 2007, any married couple [in theory, whether or not living in a
community property state, please see citations below] and who own, jointly and
participate jointly an LLC may still consider the LLC to be a "disregarded
entity" a so-called SMLLC (single member llc), and each then
can avoid filing a Form 1065 or other return and simply file, each, a Schedule
C and Schedule SE to their joint or separate Form 1040s. For
authorization, please read the citation incorporated below.
Note
that you allocate the income and deductions between the two Schedules C (and
the resulting SE) according to some logical method. This way both
spouses achieve their individual Social Security paid quarters status [and of
course pay SE taxes!] 😉 - since FICA and Medicare goes to the
individual credit and not the married couple as a couple.
Sec. 8215 of the "Small Business and Work
Opportunity Act of 2007" (4/25/07) [Please see page 10 et
ff. section I.A.5 of the following document: www.jct.gov/publications.html?func=startdown&id=1435 ] allows disregarded entity treatment of what
it refers to as a qualified joint venture which "means any joint venture
involving the conduct of a trade or business if (A) the only members of such
joint venture are a husband and wife,(B) both spouses materially participate
(within the meaning of section 469(h) without regard to paragraph (5) thereof)
in such trade or business, and (C) both spouses elect the application of this
subsection.” Assuming an LLC is a qualified joint venture [see notes at the end of this posting], this new law was effective for taxable years beginning
after 12/31/2006.
Spouses
Partnership May Elect Out of Partnership Rules - Under the Act for tax years
beginning after Dec. 31, 2006, here a qualified joint venture is conducted by a
husband and wife who file a joint return for the tax year, the joint venture is
not treated as a partnership for tax purposes. (Code Sec. 761(f)(1)(A), as
amended by Act § 8215(a))
All
items of income, gain, loss, deduction and credit are divided between the
spouses according to their respective interests in the venture ( Code Sec.
761(f)(1)(B) ), and each spouse takes into account his or her respective share
of these items as if they were attributable to a trade or business conducted by
the spouse as a sole proprietor. (Code Sec. 761(f)(1)(C)) Thus, each spouse
will report his or her shares on the appropriate form, such as Schedule C.
A
qualified joint venture means any joint venture involving the conduct of a
trade or business if:
(1)
The only members of the joint venture are a husband and wife,
(2)
Both spouses materially participate (under the Code Sec. 469(h) passive loss
rules without regard to the rule that treats participation by one spouse as
participation by the other) in the trade or business, and
(3)
Both spouses elect the application of this rule. (Code Sec. 761(f)(2))
Notwithstanding
other self-employment rules, each spouse's share of income or loss from a
qualified joint venture is taken into account under the above rules in
determining the spouse's net earnings from self-employment. (Code Sec.
1402(a)(17), as amended by Act § 8215(b)(1))
Similarly,
each spouse's share of income or loss from a qualified joint venture is taken
into account under the above rules in determining the spouse's net earnings
from self-employment for purposes of the social security benefits rules. (Act §
8215(b)(2)) Thus, each spouse will receive credit for his or her
self-employment tax contributions for purposes of receiving social security
benefits. However, this rule is not intended to prevent allocations or
reallocations, to the extent permitted under pre-2007 Small Business Act law,
by courts or by the Social Security Administration of net earnings from
self-employment for purposes of determining Social Security benefits of an
individual.
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Discrepancies and Controversy relative to whether or
not Community Property State residency is required
IRS document "Election for Husband and
Wife Unincorporated Businesses" http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Election-for-Husband-and-Wife-Unincor... clearly states the following:
"An
unincorporated business jointly owned by a married couple is generally
classified as a partnership for Federal tax purposes. For tax years beginning
after December 31, 2006, the Small Business and Work Opportunity Tax Act of
2007 (Public Law 110-28) provides that a “qualified joint venture,” whose only
members are a husband and a wife filing a joint return, can elect not to be
treated as a partnership for Federal tax purposes." "IRS citation:
Page Last Reviewed or Updated: 27-Nov-2013"
Similarly a reading of the Act itself [Please
see page 10 et ff. section I.A.5 of the following document: www.jct.gov/publications.html?func=startdown&id=1435 ] also states the same.
Nevertheless
many accountants have been cautious in applying the election of a disregarded
entity to a LLC in a non-community property state. Moreover there
are conflicting IRS documents that do not seem to have caught up with the Act
of 2007. As an example, this IRS document contradicts the Act
by stating that LLCs in non-community property states are "state law
entities":
http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Single-Member-Limited-Liability-Compa...
The
DISCREPANCY: The issue is whether or not the LLC in a non-community property
state is a "qualified business venture" or as the IRS states, a
"state law entity." As an example, New York state which is
not a community property state has the following instruction relative to NY
taxes:
"NYS
LLC Franchise Tax Form IT-204-LL say: Beginning after 2006, the $100 filing fee
payable by a single-member LLC (SMLLC) that is a disregarded entity for federal
income tax purposes has expired. Therefore, SMLLCs that are disregarded
entities no longer have to file Form IT-204-LL. In addition, the partnership
filing fee for an LLC with more than one member that is a disregarded entity
for federal income tax purposes(for example, an LLC owned solely by a husband
and wife) has expired."
If this posted response is useful to you, please click on the upraised hand in the lower left of this post. Thank you. Scruffy Curmudgeon--PFFM/ IAFF, retired FireFighter/Paramedic - Locals 718/30, Veteran USAR O3 AIS/ASA '65-'67
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