Married couples that jointly own a business often by default choose to treat the business as a partnership, which requires the business to file a partnership return. However, in many cases, treating the business as a partnership and filing partnership returns is optional. A recent Tax Court case highlights how a married couple's choice to treat a co-owned business as a partnership can work to their detriment.
Often, the default choice is to treat the business as a partnership and prepare a separate return for the business. This choice may be made for a variety of reasons, including a desire to not report gross income on an individual return because of the potential increased audit risk, or to provide liability protection for the owners.
However, there are alternatives. If the business is unincorporated and both spouses materially participate in its operation, Sec. 761(f), added by the Small Business and Work Opportunity Tax Act of 2007, P.L. 110-28, allows for the spouses to make a qualified joint venture election, under which the business will not be treated as a partnership. Rather, the spouses are treated as maintaining two sole proprietorships for all federal tax purposes, including income tax and self-employment tax.
The treatment of a business as a qualified joint venture can have several beneficial results. The business does not have to file a partnership income tax return or comply with the recordkeeping requirements imposed on partnerships and their partners. As a qualified joint venture, the business will not be subject to potential penalties for failure to file partnership tax returns pursuant to Sec. 6698. Additionally, each spouse is credited for his or her share of the earnings for self-employment tax purposes, and therefore each is eligible to make a separate qualified retirement plan contribution.
The qualified joint venture election is made by simply preparing and attaching separate Schedules C, Profit or Loss From Business (or Schedules F, Profit or Loss From Farming), and Schedules SE, Self-Employment Tax, for each spouse with a timely filed joint individual income tax return.
Alternatively, married couples living in community property states may also treat a co-owned business entity as a disregarded entity for federal tax purposes, pursuant to Rev. Proc. 2002-69. By electing this treatment, the owners are again relieved of the partnership tax return filing requirements of Sec. 6031.
The advantage of nonpartnership tax treatment was spelled out recently in Argosy Technologies, LLC, T.C. Memo. 2018-35. In Argosy Technologies, a limited liability company (LLC) was owned 50% each by a husband and wife. The IRS proposed a levy to collect unpaid income tax liabilities of the owners and imposed a penalty against Argosy for failure to timely file after the business filed Forms 1065, U.S. Return of Partnership Income, for 2010 and 2011 after the due dates. The returns included Schedules B-1, Information on Partners Owning 50% or More of the Partnership, reporting the spouses as owning 100% of Argosy. The return also included an election to be covered by TEFRA (Tax Equity and Fiscal Responsibility Act of 1982, P.L. 97-248) audit provisions. The taxpayers later petitioned the Tax Court and argued that they were actually a single-member LLC, not a partnership, and therefore were not required to have filed a partnership return.
The Tax Court held that since the LLC had represented itself as a partnership on its tax returns, it could not argue that it was another entity and disclaim its validity as a partnership. The court further noted that there was no evidence of an election under Sec. 761(f) for treatment as a qualified joint venture. Accordingly, the penalties against Argosy were upheld. Had the partnership returns not been prepared and a qualified joint venture or disregarded-entity election properly made, the penalties would have been avoided.
Practitioners must use their professional judgment when presented with a new business operation that is owned by a married couple. A careful weighing of the potential risks and rewards when advising whether to prepare a separate partnership tax return is important.
Kevin R. Sell, CPA, is a shareholder at HMA CPA PS in Spokane, Wash. Valrie Chambers, CPA, Ph.D., is an associate professor of accounting at Stetson University in Celebration, Fla. Mr. Sell is a member of the AICPA Tax Practice and Procedures Committee. For more information about this column, contact firstname.lastname@example.org.