LLC owned solely by spouses: A partnership or a joint venture?

Editor: Valrie Chambers, CPA, Ph.D.

Ordinarily, a domestic entity with two or more owners is classified as a partnership for federal tax purposes unless it elects or is required to be treated as an association taxable as a corporation. Rev. Proc. 2002-69 provides that if a qualified entity, and a married couple as community property owners of the entity, treat it as a disregarded entity for federal tax purposes, the IRS will accept the position that it is a disregarded entity. If a qualified entity, and a married couple as the owners of the entity, treat it as a partnership for federal tax purposes, the IRS will accept the position that it is a partnership for federal tax purposes.

A business entity is a qualified entity if:

• The business entity is owned solely by a married couple as community property under the laws of a state, a foreign country, or a possession of the United States;
• No person other than one or both spouses would be considered an owner for federal tax purposes; and
• The business entity is not treated as a corporation under Regs. Sec. 301.7701-2.

Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin are community property states.

A business owned by a married couple as tenants by the entirety should also qualify to be treated as a disregarded entity since the tenancy is a single ownership. The law in the state where the spouses are domiciled should be consulted.

Sec. 761(f) allows a qualified joint venture conducted by spouses filing a joint return to not be treated as a partnership for federal income tax purposes. A qualified joint venture is the conduct of a trade or business if:

• The only members of the joint venture are the spouses;
• Both spouses materially participate (within the meaning of Sec. 469(h), ignoring paragraph (5) thereof) in the business; and
• Both spouses elect this treatment.

If joint venture status is elected, each spouse files a Schedule C, Profit or Loss From Business, Schedule E, Supplemental Income and Loss, or Schedule F, Profit or Loss From Farming, as appropriate, to report his or her share of the items of income, gain, loss, and deduction. This election is not available if the business is conducted through a state law entity such as a partnership or a limited liability company (LLC), according to the instructions for Form 1065, U.S. Return of Partnership Income.

In Argosy Technologies, LLC, T.C. Memo. 2018-35, the husband and wife owners asserted that their business was a single-member LLC in order to avoid a levy to collect the Sec. 6698 penalty for failure to timely file 2010 and 2011 partnership returns. The taxpayers lost.

Argosy Technologies LLC filed partnership returns for the two years and specifically stated that its election to be covered by the TEFRA (Tax Equity and Fiscal Responsibility Act of 1982, P.L. 97-248) unified audit procedures under former Sec. 6231(a)(1)(B)(ii) remained in effect. While not specifically mentioned in the opinion, it appears that Argosy had also filed partnership returns for prior years. The court stated that since Argosy had represented itself as a partnership by filing partnership returns, it could not then argue that it was another entity. Further, there was no evidence of a Sec. 761(f) election, and the Appeals officer did not abuse his discretion in sustaining the levy. Furthermore, Argosy Technologies LLC was domiciled in New York, which is not a community property state.

Married taxpayers who wholly own an LLC in a community property state will not have to file a partnership return if the business is a qualified entity and they treat it as a disregarded entity. If the business is not held in a state law entity, married taxpayers may elect out of partnership treatment under Sec. 761(f). If, however, a married couple file a partnership return for their wholly owned business, they cannot then say it is not a partnership when confronted with penalties for late filing of the partnership return.