SPOUSES WITH AN LLC

[FIREDOGEY67]

I file and extension for 2021 taxes - it is the first year we are filing for the LLC - we do not owe taxes that I can tell at this time. My question is can we file married filing separately, as long as we split the expenses 51/49 respectively for the business income and expenses? I just want to make sure I don't screw this up. It is also the year that I claim my daughter from my previous marriage. Your guidance is appreciated.

[Mike9241]

except if you're living in a community property state, a multi-member LLC must file a partnership return.  if you don't meet this exception you are facing substantial penalties for filing late, but if this is the first time so filing, the IRS can waive them. 

it is not clear as to which spouse you were married to on 12/31/2021, if either, but I am going to assume it's the current one. why do you want to use MFS?  that will probably cost you more in taxes because certain credits are not allowed and both must use the same method  - either the standard deduction or itemized deductions. if you are not the custodial parent (the one your daughter lived with for most of the year (nights) you need a signed and dated form 8332 from your ex to claim her. it must be filed every year you claim her and must be attached to the return since you can no longer e-file for 2021. 

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as to how you want to split the partnership (LLC) income/loss. the IRS regulations specify that the allocations must have a substantial economic effect and substantiality under Regs. Sec. 1.704-1. 

Economic effect is satisfied based on a three-part test: (1) the partnership must maintain capital accounts in accordance with Regs. Sec. 1.704(b)(2)(iv); (2) liquidating distributions must be from positive Sec. 704(b) capital accounts; and (3) the partnership must contain a deficit restoration obligation (DRO). As a DRO requires a partner with a negative Sec. 704(b) capital account to contribute more cash to the partnership upon liquidation, a newly formed partnership with a DRO is exceedingly uncommon. Fortunately, Regs. Sec. 1.704-1(b)(2)(ii)(d) allows an allocation to have economic effect without a DRO, provided the partnership agreement contains a qualified income offset (QIO). A QIO allows partners to receive certain allocations that cause their Sec. 704(b) capital account to "unexpectedly" go negative, so long as they are obligated to be allocated income in the future to restore their Sec. 704(b) capital account at least to zero "as quickly as possible."

The second part of the two-part test for substantial economic performance is substantiality. For an allocation to be substantial, there must be "a reasonable possibility that the allocation (or allocations) will affect substantially the dollar amounts to be received by the partners from the partnership, independent of tax consequences" (Regs. Sec. 1.704-1(b)(2)(iii)(a)). This section largely prevents a partnership from manipulating timing differences with respect to deductions or manipulating tax rates by allocations of class of income, such as all capital gain to a partner with large unused capital losses, among others. 

[FIREDOGEY67]

This is the first time for claiming the business and we didn't have income in 2021 from the business just expenses - but all of those expenses were paid by me so essentially, he doesn't have anything to write off.

If I filed the extension as married filing jointly - then are we obligated to file jointly? 

[Rick19744]

You have a few issues going on here:

• One, is understanding whether you have a partnership tax return filing requirement.  You don't indicate whether you reside in a community property state.  As stated by @Mike9241 this impacts the decision.
• Two, is understanding the filing of your personal tax return(s).
• Three, are you both active in the business?
  • When did the business actually start?
  • What expenses were incurred?
• Until we understand all of the above, it is not possible to provide good guidance.
• You need to address this quickly, as if you do have a partnership tax return filing requirement, this return is late and penalties have accrued.

[Carl]

If "we" own an LLC, that makes it a multi-member LLC. A multi-member LLC files IRS Form 1065 Partnership/Multi-member LLC tax return. The return is due by March 15th (not Apr 18th like personal taxes are)

The Partnership/LLC will issue each owner a K-1 showing their share of profit/loss. Each owner is required to enter that K-1 on their personal 1040 tax return. If you file a joint personal 1040 return, there would be a separate K-1 entered into that return for each of you.

If only one of you owns an LLC, that's a single member LLC that gets reported on SCH C. If you elect to file separate returns, then it only gets reported on the tax return of the owner of the business. Nothing is split. Understand that when a married couple files separate returns, you "both" automatically disqualify for a number of deductions and credits you would otherwise get if you filed joint.

[Mike9241]

  ****you paid everything.   that may not matter if you have a multimember LLC.   the expenses you incurred could be member (partner) expenses but where would you deduct them? they would ordinarily be shown as unreimbursed partner expenses through the k-1 reporting for the entity but as of now there is no K-1. you can't deduct them on Schedule C. That would be misreporting which could create tax troubles. on the other hand, they might be expenses of the LLC that need to be split.  some may be subject to the rule of IRC 195 for deductibility. The IRS rules for filing a partnership return say filing is required even if there was no income but there were expenses.

**** I could find nothing that would indicate filing an extension is the filing of a return. that's because if it is a return it's too late to switch from joint to MFS. to go from joint to MFS required filing by 4/15/2022 for 2021