Partnership Question

[Zee]

[QUOTE=S T;86654]Zee, thanks for your post and questions -

In this case I am filing a form 1065 - not Schedule C - They are in Calif which is a community property state.

Is it possible to allocate "all" to the partner that materially participates and nothing to the 20% partner? Profit/Losses would be 100%, but capital and liabilities would still be 80/20?
I thought that could only be done for a Limited Partnership?

Sandy[/QUOTE065

If a 1065 Partnership return is filed (and there doesn't seem to be a choice because of the non-participation}, the typical income split would be 80/20 with both paying SE taxes (if applicable), but I'm sure you already know that.

However, it's my understanding a partnership can have a split different than the equity interest if it's in writing in the partnership agreement. Your client's isn't. I'm not sure whether 100% would be allowable, or not. I'll see if I can get a more definitive answer for you.

Why has your client chosen to treat the wife's investment as an equity interest?

[Bees Knees]

"In the absence of a partnership, the net self-employment income from a spousal sole proprietorship is allocated solely to the spouse who carries on the trade or business. (Revenue Ruling 82-39, 1982-1CB 119, equates the treatment for community property spouses to that of non-community property spouses. See also Jones, 67 TCM 1194-230, p. 3000.) The same rule applies to spouses in community property states, where the income from a business is allocated solely to the spouse exercising substantially all of the management and control even though it may be community income".

As such, the absence of a partnership agreement and non-participation seems to be the issue to me. It seems to me all the income/loss should be allocated to the spouse working the business.

I disagree with your conclusion. The absence of a partnership agreement does not equate with the absence of a partnership. The citation you quoted is talking about the absence of a partnership. That is to say, only one spouse owns and operates the business. The original post said the wife owned 20% of the business. That makes her a partner, even if there is no partnership agreement.

IRS Pub 541, page 3 says:

Husband-wife partnership. If spouses carry
on a business together and share in the profits
and losses, they may be partners whether or not
they have a formal partnership agreement.…

Owning 20% of the business means you get 20% of the profits and losses, regardless of the level of your participation.

Of course the Pub continues with the rule that allows Husband and wife partnerships to file as qualified joint ventures rather than Form 1065, but SE tax must still be allocated to each.

The only way to get the spouse out of SE tax is to have her no longer be a 20% owner.

[Bees Knees]

Is it possible to allocate "all" to the partner that materially participates and nothing to the 20% partner? Profit/Losses would be 100%, but capital and liabilities would still be 80/20?
I thought that could only be done for a Limited Partnership?

Sure you can. Have the partnership pay the husband guaranteed payments equal to the net profit of the partnership for the year. You can do that because he is doing all the work. Guaranteed payments are a deduction to the partnership, so the non-working spouse will have nothing but losses allocated to her and thus no SE tax.

[Zee]

Sure you can. Have the partnership pay the husband guaranteed payments equal to the net profit of the partnership for the year. You can do that because he is doing all the work. Guaranteed payments are a deduction to the partnership, so the non-working spouse will have nothing but losses allocated to her and thus no SE tax.

Good point, unless the year is already over which seems to be the case most of the time when the the tax preparer is involved. And, may times it would also be too late for an accrual basis taxpayer by the time they see their tax preparer.

However, I don't think that's even necessary if the partnership agreement clearly indicates the split. One example I've read indicated it's ok to have allocate net profit to one partner, and net losses to another.

Bees - I certainly don't want to debate the issue with you. IMHO, you always provide the "best answer" here on the TTB.

[Gretel]

Owning 20% of the business means you get 20% of the profits and losses, regardless of the level of your participation.

Now I have a question Bees. I thought partnerships can allocate all items in the partnership anyway they want as long as it has economic effect. Which sounds like a nice word but - if I understand this right - means keeping two sets of books, of which one is FMV. There also needs to be certain language in the partnership agreement.

[Bees Knees]

Special allocations have to be spelled out in a partnership agreement. If there is no partnership agreement, the income/loss/equity split is per ownership interest. In this case 80/20, including SE tax. The fact the wife does not participate is irrelevant.

Yes you can have a special allocation, if there is economic effect. But if the whole issue is the wife does not work, and it seems unfair to allocate SE tax to her, why not simply pay guaranteed payments for the work performed? That seems to me to be the easiest way to handle this one. That way she still owns a piece of the equity, but the husband has all the income go to him since he is the one doing all the work.

[Gretel]

Thanks, Bees, I agree with you. The key point is the non-existing partnership agreement. I wished I had some more of your clarity in defining the issue at hand.