Partnership or Sch C

[Bees Knees]

No, community property states are the exception to the 1065 rule.

Well being in a community property state and after reviewing at least the SE Rules, I see no way around filing the form 1065 if the husband and wife are truly partners. The instructions are fairly clear in that the husband and wife need to file a form 1065, then they each receive their credits for SE.

Another proof that I am correct. The IRS came out with Rev. Proc. 2002-69 which specifically says the taxpayer and spouse can file as either a Schedule C business or a 1065 partnership provided the business entity is:
1) Wholly owned by a husband and wife as community property under the laws of a state, a foreign country or a possession of the United States,
2) Not owned by any other person for federal tax purposes other than one or both spouses, and
3) Not treated as a corporation.

This ruling indicates that the IRS knows about the issue and has decided to concede (as Armando should) in the obvious case of a community property state where spouses automatically own 50% of each other’s income. Under this theory, if you were to insist on filing a 1065 every time a husband and wife were in business together, then the very idea that both spouses own 50% of each other’s income in a community property state would mean you would ALWAYS have to file a 1065 for every Schedule C business, regardless of whether or not the other spouse was a part owner of the business. The Rev. Proc. cuts out an exception to this idea saying, no, we don’t want you to always have to file a 1065. You decide how you want to report it.

We see this trend also in the argument of whether a business is an association, acting like a corporation or just a partnership. Rather than make up all kinds of rules nobody follows anyway, let’s let them decide for themselves how they want to be taxed for federal tax purposes. Thus, the creation of the so called “check-the-box” rules that let partnerships decide whether to be taxed as partnerships or corporations.

We also had a discussion recently over the passive activity rules for share crop arrangements. If you rent out your farm land for someone else to work and receive a percentage of the crops or livestock produced, and you do not materially participate in the business, you put it on a 4835. But if you just charge a flat cash fee for renting out the farm land, you put it directly on the Schedule E as rental of real estate.

Now I had never thought about it this way before, but the very idea that you would charge rent in the form of reaping a percentage of the profits of the guy renting from you is by its very nature a partnership. And the regs under section 469 confirm this. Yet IRS instructions say to use a 4835, not a 1065.

Am I right, or am I right?

[WhiteOleander]

That was me

I am the one who raised the issue of the 1065 vs the 4835.

But, they had to have a 1065 as the three siblings own the land that is farmed. But, because they lease it out to someone else for the production, the 1065 uses 4835 to report the income. Correct?

Two are only limited partners. But, one is a general partner.

I think in this case, they really need the 1065 to properly report the income to flow thru. Especially for the limited partners.

Agree or no?

[Unregistered]

"This ruling indicates that the IRS knows about the issue and has decided to concede (as Armando should) in the obvious case of a community property state where spouses automatically own 50% of each other’s income."

You're intentionally ignoring the subject of the Rev Proc.

There is a key term in the Rev Proc called "community property state." No, the Rev Proc does not apply generally to all married taxpayers in all states. The Rev Proc is specific to married individuals in community property states. To say that proves the point that a partnership return is never required for married couples in any state is to completely ignore the reference to "community property states." I'd say you don't understand what a community property state is, but I know better. You're merely being selective with the information you recognize. Alas, that's part of a larger problem. Being selective about what returns you file and what returns you don't.

Why would the IRS refer to community property states unless they meant the rules applied to, well, community property states?

I've never disputed the Rev Proc, in fact it makes sense for all the same reasons that married couples not in community property states are required to file Form 1065 if they have a partnership.

You can say that the reference to "community property states" is meaningless, and this rule is meaningless, and that rule is meaningless, all you want. But that doesn't change the tax code or filing requirements.

This is a perfect example of the sky hooks people will grab to avoid filing partnership returns. This discussion has been mostly about non-married partners who walk into the office of a tax professional who has an aversion to Form 1065. Now the excuse is "The IRS doesn't require Form 1065 for married couples in community property states. See, I told you that Bubba, Clem and Arnie don't have to file a partnership return."

Nope. You're gonna have to do better than that.

[Armando Beaujolais]

It's Me

Sorry, I forgot to log in. The above posting is mine.

[Armando Beaujolais]

Agree

"Two are only limited partners. But, one is a general partner.

I think in this case, they really need the 1065 to properly report the income to flow thru. Especially for the limited partners."

I agree.

O.K., all you anti-1065 wordsmiths out there. How do you get out of this one without filing Form 1065? File separate Schedule C's? ooops.

[BOB W]

1065 or not

Just because there is no penalty, ultimately, the IRS still expects a return to be filed. That is why they send a notice of "failure to file" and when you explain that it is an under 10 member partnership they waive the penalty.

I'm throwing this comment in as it is my 10 post to see if I become a member after ten post......................

[BOB W]

10 is not enough.........

Oh well.................

[S T]

Husband and Wife Partnership

I found this on the IRS Website. Seems like a husband and wife if they meet the definition of partners in a business, need to file form 1065.

http://www.irs.gov/businesses/small/article/0,,id=97732,00.html

Employees - Other Employment Scenarios Husband and Wife Business

One of the advantages of operating your own business is hiring family members. However, the employment tax requirements for family employees may vary from those that apply to other employees. Below, we point out some issues to consider when operating a husband and wife business.

How spouses earn social security benefits

A spouse is considered an employee if there is an employer/employee type of relationship, i.e., the first spouse substantially controls the business in terms of management decisions and the second spouse is under the direction and control of the first spouse. If such a relationship exists, then the second spouse is an employee subject to income tax and FICA (social security and Medicare) withholding. However, if the second spouse has an equal say in the affairs of the business, provides substantially equal services to the business, and contributes capital to the business, then a partnership type of relationship exists and the business's income should be reported on Form 1065, U.S. Return of Partnership Income (PDF).

Both spouses carrying on the trade or business

If spouses carry on a business together and share in the profits and losses, they may be partners in a partnership whether or not they have a formal partnership agreement. Spouses should report income or loss from the business on Form 1065, U.S. Return of Partnership Income (PDF). They should not report the income on a Form 1040 Schedule C, Profit or Loss From Business (PDF) in the name of one spouse as a sole proprietor.

If each spouse is a partner in a partnership, each spouse should carry his or her share of the partnership income or loss from Form 1065, Schedule K-1, Partner's Share of Income, Credits, Deductions, etc. (PDF), to their joint or separate Form(s) 1040. Each spouse should include his or her respective share of self-employment income on a separate Form 1040 Schedule SE, Self-Employment Tax (PDF). Self-employment income belongs to the person who is the member of the partnership and cannot be treated as self-employment income by the nonmember spouse, even in community property states. This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. However, this may not be true if either spouse exceeds the social security tax limitation. Refer to Publication 553, Highlights of 2003 Tax Changes , for further information about self-employment taxes.

One spouse employed by another

If your spouse is your employee, not your partner, you must pay social security and Medicare taxes for him or her. The wages for the services of an individual who works for his or her spouse in a trade or business are subject to income tax withholding and social security and Medicare taxes, but not to FUTA tax. For more information, refer to Publication 15, Circular E, Employer Tax Guide.

Sandy

[Bees Knees]

Community Property

Why would the IRS refer to community property states unless they meant the rules applied to, well, community property states?

I've never disputed the Rev Proc, in fact it makes sense for all the same reasons that married couples not in community property states are required to file Form 1065 if they have a partnership.

You can say that the reference to "community property states" is meaningless, and this rule is meaningless, and that rule is meaningless, all you want. But that doesn't change the tax code or filing requirements.

Now this is interesting. You go on and on and on and on about how it is OK for community property states to ignore 1065s, because, well, because IRS said so….that’s why. In fact, it makes perfect sense. Why?? Well…..because IRS said so…that’s why.

Why Armando???? Why does it make perfect sense for community property state husband wife partnerships to skip filing a 1065? Why, other than because IRS said so?

What was their reason for saying it?

I’ll tell you why. It is because in a community property state, 50% of your spouse’s income and earnings is yours, and 50% of yours is his or hers. What does it indicate when you and another person share profits? Hmmnnn? Common’ now, you know….When you share profits you are….a….ummmm….a…..PARTNERSHIP. BINGO…..Ding ding ding ding ding.


Community property states by law are states where husband and wives are partnerships. The laws were created so that one spouse shares the profits of another. A spouse cannot make the claim that he or she personally earned the income so that their no good so and so cheating ex spouse doesn’t deserve any of it in a divorce proceeding. States got tired of that argument, so they said, guess what. You two lived together, were married, shared everything, you both contributed to the success of one another, so you two are PARTNERS. That means you both get 50% of each others efforts.

So back to the tax ramifications. If couples in community property states are by law partnerships, then you could never claim that one spouse earned income as a sole proprietorship, could you? If you are in a partnership with someone, how can you say you are the only owner when someone else is also an owner? That means in community property states, under federal law, ALL sole proprietorships are really partnerships. And so they have to file form 1065 as a partnership, because they are a partnership. Period.

Now comes the IRS saying, wait a minute. We didn’t mean to burden taxpayers with that. No, you don’t have to file a 1065 every time you do some side business to earn a few extra bucks. No, you can file Schedule C as a sole proprietorship, even though the law in your state says you and your spouse are partners.

That is the purpose of the Rev. Proc. State law says they are partnerships, but the IRS gives them an exception to the rule. JUST LIKE another Rev. Proc. that says there is no penalty for 10 or fewer partnerships that decide not to file a 1065 as long as they report all income, deductions, and credits properly on their 1040. If one Rev. Proc. works, why do you insist the other doesn’t? Hmmmmmm????

[Armando Beaujolais]

It's Elementary

I must acquiesce to the voice of reason and insight, and proclaim complete agreement with the person with definitive substantial mastery of the subject at hand.

"Seems like a husband and wife if they meet the definition of partners in a business, need to file form 1065."

Thank you Sandy. I couldn't have said it better myself.

"Now this is interesting. You go on and on and on and on about how it is OK for community property states to ignore 1065s, because, well, because IRS said so….that’s why. In fact, it makes perfect sense. Why?? Well…..because IRS said so…that’s why.

"Why Armando???? Why does it make perfect sense for community property state husband wife partnerships to skip filing a 1065? Why, other than because IRS said so?"

I'm glad you're finally discovering that compelling theoretical tax discussions are interesting. However, I never said that community property states "ignore" 1065's. I do believe that it makes perfect sense for husband and wife partnerships in community property states to skip filing a 1065. Why? Listen closely now.

What's the purpose of a 1065? Is it to change the character of income? No. Is it to escape SE tax? No, at least for purposes of this discussion. Is it to make filing easier? Probably not. Why, then, is there Form 1065, instead of a separate Schedule C for each partner involved?

It's all about reporting. Allocating, reporting, matching. It's a paper trail.

It makes perfect sense for a married couple in a community property state to ignore Form 1065 because the income is already allocated. Everything is 50/50. Why would you need to allocate, report, and match when everything is automatically 50/50? It wouldn't make sense. It wouldn't make sense because it doesn't make sense, not because the IRS says so. If it doesn't make sense and it wouldn't make sense, it's not going to make sense if you try to make sense out of something that doesn't make sense in the first place. If that doesn't make sense to you, I suggest you take some sense-making classes at the community ed center. I think they might have some sense-making focus groups down at the jr high for people with that problem.

Treatment of partnership income depends on the status of the recipient. Can a corporation be a partner? Of course. If the treatment of income depends on the status of the end recipient of the income, how can you pre-determine how income is treated before it's ever distributed? You're trying to classify income and expenses for a partnership at the partnership level. That's not how it works. Except, of course, in community property states, where allocation is already established at 50/50 for married couples.

Or 50/50 for civil unions. Uh oh. I would never want to stir up a controversial tax issue. Some states have changed their tax laws to "civil unions" instead of "married filing joint." Are any of those states community property states? Oh never mind.

[Bees Knees]

Making perfect sense to me now, thank you.

I do believe that it makes perfect sense for husband and wife partnerships in community property states to skip filing a 1065. Why? Listen closely now.

What's the purpose of a 1065?

It's all about reporting. Allocating, reporting, matching. It's a paper trail.

It makes perfect sense for a married couple in a community property state to ignore Form 1065 because the income is already allocated. Everything is 50/50. Why would you need to allocate, report, and match when everything is automatically 50/50? It wouldn't make sense.

Treatment of partnership income depends on the status of the recipient.

After several hours of making sense therapy this morning, I have finally discovered that you and I are in complete agreement on this issue. Yeah. We AGREE, finally…..(audience gasps a huge sigh of relief….)

You are absolutely correct. It IS all about reporting. A 1065 is a reporting tool. It is needed for the sole purpose to allocate income, deductions, and credits to the various partners, so that the proper treatment of such income, deductions, and credits can be realized on their final destination, a journey that takes them to a 1040, where peace and tranquility and all kinds of happy thoughts reside…..

And it makes perfect sense, as you suggest, that the community property couple need not bother with a 1065 because everything they do is already a 50/50 deal. Why, as you suggest, would there be any kind of need to “allocate, report, and match when everthing is automatically 50/50?”

Those were your words, correct? I mean I don’t want to be accused of trying to impersonate you or anything. I do not want our friend Mr. Sham to think I have set myself up with the perfect come back now. You DID just say that, didn’t you? My perfect sense making class didn’t just give me delusional fact patterns now….

But……

And I don’t mean for you to change your mind or anything like that, because I DO agree with you here…..

But if it is true that a community property state husband and wife business skip the 1065 because their income, deductions, and credits, are all ready allocated on their 1040, what about the fact that community property state laws only come into play on a federal return for purposes of Married Filing Separate? I mean, there really is no difference filling out a 1040 in a community property state vs. a 1040 in a non-community property state, is there? Except when you file separate 1040s. Then the community property state rules kick in as to proper allocations and all that good stuff.

So under your reason just given, and like I said, I agree with it 100%, then the community property state reporting does not need a 1065 for the same reason a non-community property state married filing joint 1040 does not need a 1065.

Income, deductions, and credits on a married filing joint return in a non-community property state are already properly allocated. As you yourself said: “Why would you need to allocate, report, and match when everything is automatically 50/50?” Other than the SE tax issue, a married filing joint return is automatically 50/50, whether you live in a community property state, or a non-community property state.

[Unregistered]

Bees Knees

You really don't know what you are talking about, and I'll leave it at that.

[Armando Beaujolais]

That's Right!

Finally someone with some sense. I guess we'll just call the issue settled now.

[Bees Knees]

You really don't know what you are talking about, and I'll leave it at that.

Yeah, I know. I probably had too much coffee that day. Armando, why can’t you make convincing rebuttals like that?

[S T]

More C vs 1065

Okay, are we trying to resurrect the age old conversation of Schedule C or Form 1065?? There is still that SE issue on h/w as a partnership!

I am still leaning toward the side of Form 1065, husband and wife partnership! (community property state)

Sandy