How do I change from a form 1065 partnership to a single member llc that would be reported on a schedule C?

[DanielV01 · Accepted solution]

You need to prepare a Final Partnership return.  This final return should show that one partner is liquidating his/her/it's assets in the partnership and turning the business over to the single member.  You will still need to fulfill your state's requirements for maintaining the LLC (any tax or registration fees that are imposed for the LLC designation), and you do well to advise the IRS of the change of entity (from a partnership to a disregarded entity Sole Proprietorship) associated with the LLC's EIN.  If you do these things, next year the single member may file the business as a disregarded entity sole proprietorship using Schedule C.

[sandphill]

My husband and I have a 50%  50% partnership LLC.

I would like to retire and wonder if I can stay on the partnership and change it to a 100% to 0 or 99% to 1%.

Do I have to file a Final Partnership return.

[AmyC]

@sandphill

You and your husband have a partnership. You either file a partnership return now or you file two schedule C forms.

If you are filing a partnership return, you will have to adjust the numbers for ownership. If you are filing 2 schedule C's each year, you could just quit filing yours.

While you know if you are filing a partnership return or 2 schedule C's, not everybody may realize that the option for 2 schedule C's is limited by where you live. If you live in a community property state, you qualify for the 2 Schedule C's.

If you are not in a community property state, you are filing a partnership return, definitely.

@Rick19744 thanks for catching that this would be confusing to new folks without the edit.

[Edited 04/10/20 | 5:15pm PST]

[Rick19744]

@AmyC said:

You and your husband have a partnership. You either file a partnership return now or you file two schedule C forms.

@AmyC doesn't this only work if they are in a community property state of which we don't know the answer?

[georgen0w]

Can you mark a 1065 as the final return and file a schedule C the following year as a qualified joint venture (MFJ)?

[Carl]

If you filed a 1065 Partnership Return in 2018, then you have to file a "final" 1065 Partnership return for 2019. Period.

In order to close the partnership without selling it, the partnership must show the disposition of all assets and the distribution of any cash. If the partner's are married and filing a joint 1040 personal tax return, then both partners of the partnership can simple show that all assets were removed from the business for personal use and all funds were withdrawn by the partners. If the partnership was started with any capital contributions (cash or assets) make sure to indicate those contributions were returned to the contributing partner, so there's no tax implications. This is referred to as a "return of capital contribution".

If the partnership has inventory, then it should be "removed for personal use" by/to the person that will continue the business as a single member LLC.

Several things have to be true for the partnership to be considered closed/disolved by the IRS (and your state).

1) All assets owned by the partnership must be disposed of somehow. In your case, it would probably be disposed of by either showing it as a "return of a capital asset" to the partner that contributed it, or as compensation to one of the partners, or as removed for personal use by one of the partners.

2) All cash balances must be zero, and all outstanding monetary transactions need to be settled. (I said "settled", not necessarily paid off. There's a difference.)

3) If the partnership carries inventory, then the End of Year Inventory Balance *MUST* *BE* *ZERO*. The easiest way to accomplish this is by showing that inventory as" removed for personal use" or as compensation to one of the partners.

Once the "finaL" 1065 is completed, filed and accepted by the IRS and all "final" K-1's are issued to all partners, then and only then are you ready to start your personal joint 1040 tax return.

For the SCH C, the start date of the business will be the "ORIGINAL" start date of the partnership - doesn't matter if it was years or decades ago either. If any assets will be transferred to the SCH C business then the "in service" date for those assets is the "ORIGINAL" in service date from the partnership -doesn't matter if it was years ago either. This is the "ONLY" way to properly and correctly account for and report prior year's depreciation already taken on those assets, when they were in the partnership.

If the single member LLC will have inventory from the partnership, then understand that for the SCH C business the beginning of year inventory balance *MUST* *BE* *ZERO*. This is not something that's up for discussion really, because there are no exceptions to this. That's just the "way it works" in the COGS section, and it's right too.  But if inventory is involved I'll be happy to help you understand it when you get to that point in the SCH C section of the program.  It can be difficult to wrap your head around it. But once you "get it" a great big light bulb illuminates over your head and it all makes sense.

[tiffany3612]

if one partner is liquidating his assets in the partnership,

1- would IRS allows him to use same EIN for filing single member LLC next year? 

2- is there a form to advise IRS of the change of entity?  I tried 8822-B, but not sure if it a correct form or not

thanks

"You need to prepare a Final Partnership return.  This final return should show that one partner is liquidating his/her/it's assets in the partnership and turning the business over to the single member.  You will still need to fulfill your state's requirements for maintaining the LLC (any tax or registration fees that are imposed for the LLC designation), and you do well to advise the IRS of the change of entity (from a partnership to a disregarded entity Sole Proprietorship) associated with the LLC's EIN.  If you do these things, next year the single member may file the business as a disregarded entity sole proprietorship using Schedule C."

[martinlc]

@AmyCYour answer is really helpful. I'm glad I found it by searching for this topic.  My wife and I each own 50% of an LLC. We've been filing partnership return so far, but for 2020 and beyond, we'd like to file 2 schedule C's instead (we live in Texas, a community property state) for simplicity. How do we notify IRS of this change?  If we just stop filing the partnership return, I suppose IRS would think we failed to file the partnership return on time and issue penalty, since the partnership tax return is due earlier than personal tax return. Thank you!

[DanielV01]

@martinlc  What I would recommend is to amend your 2019 partnership return and make it a final return that distributes out the remaining assets of the partnership, so that the final capital account is 0.  This has to be done to close out the partnership, and it is accurate because Schedule C is simply considered personal income that does not require you to maintain a capital account. 

Now, doing this will force you to amend the 2019 personal return as well, as the IRS would get amended Schedules K-1 that would have to be reconciled.  But as long as the distributions bring each partner's capital account down to 0, there is no tax consequence; just reporting.  It would avoid having to do a final partnership return for 2020, and you could then proceed with filing two Schedules C in a qualifying joint venture.  You will want to include a statement that makes that election and states that you qualify to do so because you live in a community property state.  Of course, you must divide everything 50-50.  You don't have another option if you choose this method.

[Rick19744]

@martinlc I don't agree with amending the 2019 LLC tax return to accomplish this.

Too much time has elapsed and I think it is unwise to amend the 2019 partnership return which in effect is telling the IRS "Oh we forgot that we distributed out all the assets".

My recommendation is to file the 2020 Form 1065 as a final tax return which will reflect the liquidating distributions.  I would also include a statement that the LLC taxed as a partnership is being liquidated and going forward you will be filing as a qualified joint venture in accordance with Revenue Procedure 2002-69.

Make sure you mark all appropriate boxes that this is the final form 1065 and the K-1's are marked final as well.

Going forward, for your tax year 2021, you will just split the activity with each of you completing a Schedule C.

Keep in mind that you can no longer use the EIN that was assigned to the LLC.  Filing a Schedule C does not require you to get an EIN unless you have employees.  Just use your SS#.  Make sure any vendors, banks, etc. no longer send you documentation that references the LLC EIN.

[DanielV01]

@martinlc  What @Rick19744 states is not wrong.  I do agree that it is better from both an accounting and tax standpoint to finalize the partnership in 2020 and begin the Qualifying Joint Venture beginning January of 2021.  My comments went to how it would be possible to begin the QJV in 2020.  What I stated is possible, but I agree that it wouldn't be recommended.

If you were to amend/supersede the 2019 return, it would open up the possibility of the IRS asking questions as Rick19744 mentions, and then you'd have to prove the stance.  You probably could do that, because if the only partners in the LLC are you and your spouse, then everything is staying "in house" as it were, and it would not be impossible for your records to be reconstructed to show this.  (As I mentioned before, a QJV doesn't need to worry about capital accounts like the partnership does, and this all is "your money" in the end).  But if that happens, what you look to save in time/money from having to do a partnership return in 2020 would be eaten up by all these hoops you'd end up jumping through to prove everything with the IRS.  So I thank Rick19744 for providing that clarifying information, and hope you make the best decision for your situation.

[turner8289]

I am currently in a similar situation. But our LLC was created October of last year and had no activity at all. We originally wanted to do it as a partnership so when filling for EIN IRS send a letter with the EIN number recommending to file 1065. In fact, we never used LLC as a partnership and always operated as a single member. Can i disregard this recommendation by IRS and file schedule C this year since LLC has not been active and does not have any assets?

[Wonderwoman49]

@DanielV01  @Rick19744  We are in a similar situation. 

Florida LLC, Husband and wife and have been filing 1065 partnership returns the past few years. We decided it would be better to make the LLC a single member LLC.  If we were to make this amendment with the department of state as well as submit form 8822-B to the IRS (changing Responsible Party to the remaining LLC member (husband), would we still be able to mark our 1065 return for 2020  as our final return and then report all 2021 income on schedule c? The 1065 income is under 250K, so we have not had any obligation to report our capital accounts. Or, is it too late to make such a change, given we are already 10 weeks into the new year?

Would greatly appreciate your advice! 

[Rick19744]

@Wonderwoman49 you need to check with the Florida Secretary of State office.  I don't know if you can retroactively dissolve the LLC.  Additionally, I do not know if Florida would require you to establish a new single member LLC.  Each state is different.

If you are able to do so, then "yes" you would be able to file a final federal form 1065 for 2020; and Florida partnership return.

Keep in mind, that you will not be able to use the LLC EIN going forward.  Should you need an EIN for the SMLLC, you will need to obtain a new one.

Not sure a form 8822-B is necessary.  Filing the Schedule C with your husband's name is essentially informing the IRS that this business is your husbands.

Also keep in mind that the partnership return is due 3/15.  So you will clearly need to extend this return.

As noted in a previous comment, there are a number of federal issues that come into play when making liquidating distributions.  It may be wise to consult with a tax professional.