Updates and guidance on key IRS practice developments.

• Author: Chambers, Valrie

Practice & Procedures

Filing 'optional' partnership return costly

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...