What does Change of Ownership Greater than 50% require in Husband Wife LLC Partnership Require?

[cwilliambrown]

My wife and I planned to change the ownership percentage when filing our 2021 return. We live in SC, which is NOT a community property state and does NOT require us to file an Operating Agreement.

When I got to the change of ownership section in TT Business, I just happened to click on "Explain This" before entering the new percentages. I believe this is saying we need to file one return with the current percentages as they were last year and then file another return with the new percentages.

We made this decision in 2020 and we considered it effective Jan. 1, 2021.  Can someone please help me understand why (or if) we need to file two returns. 

[tagteam]

I will page @Rick19744 for this, but why are you changing ownership percentages?

Even if one of you is not going to be involved in the operation of the LLC (or management), the actual ownership percentages do not have to change. 

[Critter-3]

Ok ... if you both own the partnership before and after changing the %  then you did NOT have an ownership change that would require you to file 2 separate(before & after) form 1065.  As spouses you can change the ownership % at will.  

[cwilliambrown]

Thanks so much @Critter-3 

That seemed like the logical answer, but I wanted to be certain and couldn't find any answer elsewhere. 

[Rick19744]

Most states simply permit the adoption of an operating agreement.

While that may be the case, not formalizing an operating agreement is certainly in the minority and not a wise decision.

An operating agreement is to an LLC what a partnership agreement is to a partnership.

Without an operating agreement, should there be an issue, there is no formalization of how the members intended to deal with the matter; divorce, change in member, change in member ownership, death of a member, etc.  This can lead to significant legal costs to resolve a dispute, which will outweigh the cost of drafting an operating agreement.

Additionally, the operating agreement provides for the allocation based on the economics of the formation.  Since an LLC is generally taxed as a partnership, the IRS does not like, and has specific provisions, for how income, loss, etc. are allocated.  The overriding allocation is based on complex substantial economic effect.  In other words, the IRS does not like shifting of tax consequences at the whim of the partners or between family or partners in different tax brackets unless these allocations pass the complex substantial economic effect regulations.  Many LLC’s have an allocation that is based on the member’s interest in the LLC, which is based on economics.

Can you change the ownership allocation? Yes

Should there be some economic reason for doing so? Yes

Since you are most likely filing a joint individual tax return (form 1040), the end result will be the same from a federal income tax standpoint.

What does change is the SE Tax component and the SS ramifications.

So do you need two 1065’s? “no”.  Any change in ownership would be handled through the allocation process. 

Additionally, you only have an oral agreement; nothing in writing.  Based on that, I would think that you should be able to make the change effective 1/1/2021.  But keep in mind, I also believe there should be some substance to the change, but this is minimized due to most likely filing a joint 1040.

Since you are changing the “partnership interest” percentage, there will most likely be a question asking if the decrease was the result of a sale or exchange.  You will answer this “no” based on your facts.

[cwilliambrown]

Thanks for the additional information @Rick19744 

It gives us a few things to think about. We treat everything as "ours" and it's hard to image that ever changing. We aren't changing it in an effort to avoid taxes. I've become much more involved in the business as it's grown. We're changing it to reflect this, but ultimately the reason for doing this is to reflect a higher income for myself so that I can a a rental property. Mortgage in my name only, but with both names on the need. We managed to purchase our home in her name only. In a couple of years this would put us in a position to save the 20% down and my income alone should be sufficient to secure a mortgage on a rental property.

Please let me know if this is illegal or would cause us problems in some way. If you own a small business, you know the hoops you have to jump through the get a mortgage. I learned a lot doing all the paperwork for the mortgage own our home. I'll have to provide two years of income and this is a way to bump that number up enough to ensure we (I) get approved.