Avoid Partnership Tax Filing with Two Little-Known Elections

As you know, running a business often means filing a separate business tax return. 

If you own an unincorporated business or another activity with anyone besides yourself, you likely have a partnership for federal tax purposes. This requires you to prepare and file a partnership tax return, and then issue Schedule K-1s to the partners so they can report the partnership’s taxable items on their separate tax returns. 

In some cases, you can avoid multiple tax filings and elect out of partnership treatment for federal tax purposes, and simply put the activity directly on your individual tax return! 

But you may not be aware that for certain partnerships, you can avoid the separate return and report the activity directly on your individual tax return, such as for the three activities below:

1. The qualified joint venture election is available if you and your spouse are the only partners. Under this election, you file no partnership returns and simply report the income and expenses on Form 1040, Schedule C. 
   
   This election does not work for spouse LLCs taxed as partnerships, except for those LLCs in community property states like California.
    
2. The Section 761(a) election is available for non-related owners, but for a limited set of activities, such as investment partnerships.
   
   If your partnership elected out, you report your respective share of the items of income, deductions, and credits of the organization on your respective tax return on the appropriate form or schedule.
   
   And one more important note: most state LLC acts preclude LLCs from electing out of partnership treatment by providing that the LLC, not the members, owns the LLC’s property.
    
3. Rental properties aren’t partnerships for federal tax purposes if you and your fellow owners have only to keep the property maintained, in repair, and rented or leased. This is simply a “co-tenancy.” This means you and your co-owners can report ownership interests on your personal tax returns without making a special tax election.

By reporting separately, you dramatically simplify your tax return filings and compliance requirements. You can benefit from these elections for several reasons: 

• You don’t have to file a separate partnership return.
• You don’t have a partnership that faces the failure to file the partnership return penalty of $195 a month times the number of partners.
• You don’t have to track basis in the partnership interest, or worry about distributions in excess of basis (which cause capital gain recognition). 
• It is simpler to take the self-employed health insurance deduction as a sole proprietor than as a partner in a partnership. 

You might want to avoid these elections under any of these circumstances:

• The partnership wants to make special allocations of tax items not in accordance with the partner’s ownership interests. 
• You believe your business is at high risk of an IRS examination. Statistically, the IRS examines a far larger proportion of Schedule Cs and Schedule E’s than partnership returns. 
• The election increases your and your spouse’s self-employment taxes but there are ways you could avoid this.

If you would like to discuss any of the three non-partnership possibilities above, or if you or your spouse receives a notice from the IRS asking for a partnership return, don’t hesitate to call us.