Husband Wife LLC

[DaveO]

My client owns a small business at which she has been very successful. We have filed Schedule “C” for several years. She got married and on the advice of her attorney formed an LLC making her husband 50% owner. Husband has provided capital but no labor for the business but enjoys the profits of the business (he works a regular job). Since I have to file the 1065 form do I consider his ½ of the profits subject to SE tax or not? If they were not married he would not be subject to SE tax, does that change since they are? At a gut level I would think all profit would be subject to SE tax but can’t find a clear answer. They are not in a community property state.

[Koss]

Husband-Wife Partnership

If he is only a passive investor in the business, then it may not be subject to self-employment tax.

With that being said, there are some new rules for husband-wife partnerships that allow you to avoid filing a 1065 in some cases, and simply file two separate Schedules C. Your client may be eligible to do this.

But if you do it that way, then his share will certainly be subject to SE tax.

BMK

[Gretel]

I don't think a partnership LLC has the option not to file form 1065, not matter who the owners are.

In a LLC (since everyone has limited liability) you might be able to exclude some of the profits from SE tax, even for working members, depending on the facts and circumstances. To my knowledge, the IRS has not ruled on this issue yet.

It might be worthwhile to research this board some years back. There have been intense discussion on the subject.

[Koss]

Qualified Joint Venture

The following text is from the instructions for Schedule C:

Husband-Wife Business

Generally, if you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement. Do not use Schedule C or C-EZ. Instead, file Form 1065. See Pub. 541 for more details.

Exception—Qualified Joint Venture

If you and your spouse each materially participate (see Material participation on page C-3) as the only members of a jointly owned and operated business, and you file a joint return for the tax year, you can make a joint election to be treated as a qualified joint venture instead of a partnership. By making the election, you will not 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.

Note.

Mere joint ownership of property that is not a trade or business does not qualify for the election.

Making the election. To make this election, you must divide all items of income, gain, loss, deduction, and credit attributable to the business between you and your spouse in accordance with your respective interests in the venture. Each of you must file a separate Schedule C, C-EZ, or F. On each line of your separate Schedule C, C-EZ, or F, you must enter your share of the applicable income, deduction, or loss. Each of you must also file a separate Schedule SE to pay self-employment tax, as applicable.

If you have employees or otherwise need an employer identification number (EIN) for the business, see www.irs.gov, keyword “qualified joint venture,” for more information.

Once made, the election can be revoked only with the permission of the IRS. However, the election technically remains in effect only for as long as the spouses filing as a qualified joint venture continue to meet the requirements for filing the election. If the spouses fail to meet the qualified joint venture requirements for a year, a new election will be necessary for any future year in which the spouses meet the requirements to be treated as a qualified joint venture.

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 C or C-EZ instead of 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 and using the Schedule C or C-EZ does not alter the application of the self-employment tax or the passive loss limitation rules.

Exception—Community Income

If you and your spouse wholly own an unincorporated business as community property under the community property laws of a state, foreign country, or U.S. possession, the income and deductions are reported based on the following.

If only one spouse participates in the business, all of the income from that business is the self-employment earnings of the spouse who carried on the business.

If both spouses participate, the income and deductions are allocated to the spouses based on their distributive shares.

If either or both you and your spouse are partners in a partnership, see Pub. 541.

If you and your spouse elected to treat the business as a qualifying joint venture, see Exception—Qualified Joint Venture on this page.

The only states with community property laws are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. A change in your reporting position will be treated as a conversion of the entity.

But on your fact pattern, they do not appear to qualify for this election, because he does not materially participate. His share of the income may not be subject to self-employment tax, and it may be considered passive income.

BMK

[Jesse]

Two schedule C's can be filed for H/W LLC in a community property state instead of the Form 1065, but as Burton pointed out if they do that they must pay SE tax on income for both H & W.

[DaveO]

Filing of the 1065 is forgone since they have formed the 2 member LLC and obtained an EIN. I'm just hoping to cut the SE tax burden since she is the only member providing services. If I could elect to file two schedule "C"'s he would have to pay SE tax.

It's the substance over form arguement that has me stuck.

Since she is the only one working all income would be subject to SE tax were it not for the LLC. Does the mere fact that he gets 1/2 of the income change the character of the income from self employment to passive?

[Burke]

Does she actually pay him 1/2 of the income? Or does it just flow thru on the K-1's. You can adjust the percentage on the K-1's based on ownership and participation.

[DaveO]

It's about 50/50. She writes checks to him because she feels funny writing checks to herself. Her draws are mostly for taxes and personal stuff. The money taken out to use for personal living expenses are mostly checks written to him.

[dsi]

You should read their articles to see if he is/isn't considered a manageing member?

[Burke]

It's about 50/50. She writes checks to him because she feels funny writing checks to herself. Her draws are mostly for taxes and personal stuff. The money taken out to use for personal living expenses are mostly checks written to him.

Well, I really don't see what difference it makes. If the profits are paid out to either of them, it would be subject to SE tax, IMO, because it would be constructive receipt into the same household used for joint expenses. Anthing else looks like evasion of SE. And if it all went to one of them, it still would come back in on the joint return, and would be subj to SE. The only thing is whose account would be credited with the earnings, which might cause a problem if he is taking early SS or she is and the amt exceeded the amt they could earn before SS payback, etc.

[New York Enrolled Agent]

The following text is from the instructions for Schedule C:



But on your fact pattern, they do not appear to qualify for this election, because he does not materially participate. His share of the income may not be subject to self-employment tax, and it may be considered passive income.

BMK

Actually, there is an even more compelling reason why they can't do the election. The poster indicated that H & W formed a two person LLC.

Here is a paste from the IRS (for the record some commentators suggest there is no basis in the law for this):

A business owned and operated by the spouses through a limited liability company does NOT qualify for the election
Only businesses that are owned and operated by spouses as co-owners (and NOT in the name of a state law entity) qualify for the election. See Rev. Proc. 2002-69, 2002-2 C.B. 831, for special rules applicable to husband and wife state law entities in community property states.

[S T]

Nyea

Thank you for that info!

Sandy