Reporting Options for Spousal Businesses

Many spouses can avoid filing a partnership return

Two spouses often decide to operate a business together (then get divorced). There are unique reporting options for how the spouses report their jointly conducted business, but their choices may be limited by how they choose to organize it.

Default Treatment

Under Treas. Reg. §301.7701-1(a)(2), a trade or business jointly conducted by two spouses outside of a state-level entity is a partnership for federal tax purposes:

A joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits therefrom.

If the spouses conduct a trade or business in a jointly-owned limited liability company (LLC), the entity is a partnership for federal tax purposes under Treas. Reg. §301.7701-3(b)(1)(i).

Qualified Joint Venture

A business conducted as a joint venture by two spouses can elect to be a qualified joint venture (QJV) under §761(f) instead of being a partnership. If the spouses make a QJV election, they report their share of the business as a sole proprietor.

A jointly-owned LLC is ineligible for the QJV election per IRS guidance; in JCX-29-07, the Joint Committee on Taxation stated that

The provision is not intended to change the determination under present law of whether an entity is a partnership for Federal tax purposes (without regard to the election provided by the provision).

To qualify for the QJV election, §761(f)(2) has three requirements:

1. The spouses have to be the only members of the joint venture,

2. Each spouse must materially participate in the joint venture (without the imputation of any spousal participation in the activity), and

3. The spouses must make a QJV election on a joint return.

IRS instructions state that the spouses make the QJV election by dividing the business’s items of income, gain, loss, deduction, and credit based on each spouse’s interest in the joint venture on separate Schedules C or F and Schedules SE with the joint return. Please note that it does not have to be a 50/50 allocation if the spouses do not have equal interests in the venture.

Once the spouses make the QJV election, they must get IRS permission to revoke it; however, the election will only remain in effect for as long as the spouses continue to meet its requirements, so filing separate returns would rescind it.

The IRS never issued formal guidance concerning §761(f), but it maintains a website that addresses all essential QJV issues.

Rev. Proc. 2002-69

In Rev. Proc. 2002-69, the IRS announced that an LLC held as community property by two spouses can be treated as either a disregarded entity or a partnership, and the IRS will respect the spouses' choice. Please note that this option is neither an entity classification election nor a §761(f) QJV election.

The spouses can change the treatment if they choose; however, according to the revenue procedure, “A change in reporting position will be treated for federal tax purposes as a conversion of the entity.” Changing from a disregarded entity to a partnership will be a §721 tax-deferred exchange, and changing from a partnership to a disregarded entity will be a partnership liquidation, which may be a taxable event.

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