Business & farm

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:

1. 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.  
   
   
2. 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. 
  

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."