Partnership & Home Office

June,

My wife and I started an independent consultant business last year in Fairfax, VA. We file partnership returns and have a home office. In doing our taxes, we were told that home office expenses are supposed to be captured in Schedule E and attached to Form 1040.

However, another advisor also said that we can reimburse home office expenses throughout the tax year through our income distributions and then capture them as other deductions on Form 1065 (the partnership return). This would be easier since we wouldn't have to fill out Schedule E so that is what we did.

Did we do the right thing?

Thanks, Matt


Wrong thing, Matt. A basic, really basic, piece of info on tax prep: If there is income from a partnership you must include that income on a Federal Schedule E. This is another example of why I think indies should not prepare their own tax returns.


Since a partnership is the least tax advantageous entity for a husband and wife business you might want to read some posts here payroll -- spouse as employee or here husband-wife business to learn more.

Partnerships have very specific rules on deductions. If you want to deduct the costs of a home office, although not required, I would suggest writing into the partnership agreement that home office use is expected. Deductions for a home office may be taken on Schedule E only. This will reduce a partner's self-employment income and self-employment tax liability.

You may not take home office expenses on the partnership return. And, do not rent to your partnership. That's a real kettle of worms and maggots!

Best,
June

Husband-Wife Business? Don't set it up as a partnership.

June,

I am preparing to take the plunge into SE and your book Self-employed Tax Solutions book has been an excellent resource.

Due to the work I do and subsequent contractual liability concerns, it was in my best interest to form an LLC, which I did as a single member.

My spouse will work in this venture in a part-time/full time business management capacity while I provide billable consulting services.

Are we better off with my spouse as a member, thus a partnership LLC, or as an employee in a single member (sole proprietor) LLC? I want the maximum liability protection, and equal "ownership" but do not want to give Uncle Sugar anymore than I absolutely have to. Since we file jointly, I'm thinking the tax advantage lies with the sole proprietor option but need your advice.

Thank you in advance.

Dean from Fort Collins, CO


Hello Dean,

Very smart move -- getting information before you make a decision!

An LLC treated as a "disregarded entity" is a sole proprietorship.

The most tax advantageous business structure for a husband-wife business is that which has one spouse as the sole proprietor and the other spouse as an employee of the sole proprietorship.

The least tax advantageous is a husband-wife partnership.

For an understanding of the advantages read my posts in the category payroll -- spouse as employee.

Glad my book is a good reference for you. Please tell your indie friends and colleagues!

Best,
June

SE Tax and Partnerships

Hi,

My husband currently receives a 1099 & is self-employed as a territorial sales rep.

He pays alot on self-employment [SE] tax. We are thinking about opening up a retail store in which we would be partners in an LLC.

Does The Small Business and Work Opportunity Tax Act of 2007 mean that we would not need to file for SE tax on this small business? If I am understanding it incorrectly & we still do need to file SE tax, is there some way we can combine his territorial sales rep work in which he already pays SE tax with the small retail business, so that we are not paying SE tax on two related businesses?


Also, does the Small Business and Work Opportunity Tax Act of 2007 eliminate the double taxation that occurs with husband & wife partnership llc's?

Thanks, Eileen


Hello Eileen,


Wow! You are mixing up apples, potatoes and Fruit Loops.

First of all, there is nothing in the Small Business and Work Opportunity Tax Act of 2007 that eliminates SE tax. To make sure there was no hidden paragraph that I missed I called the IRS to confirm. If you found something that says it's been eliminated, please send it to me.

Second: There is not now nor was there ever a double taxation of SE tax. Read What is Self-employment (SE) Tax? on this blog.

In a partnership SE tax is paid on the net profit. For instance, if you and a friend were 50/50 partners then each of you would pay SE tax on half the profit. A husband and wife partnership would also split the profit and pay SE tax on his and her share.

By the way, a partnership is the least tax advantageous business structure for a husband and wife business. A better way: One spouse as owner, the other as an employee.

Best,
June

LLCs, Partnerships and Self-employment Tax

Rhonda from NY asked a multi-part question a while ago. One part of her question was answered here I am an LLC. How do I pay taxes? And now that I've successfully met the October 15 deadline for a lot of slow-to-get-to-it clients I can answer the other part of her question.

Rhonda's situation and questions are:

I am starting an LLC in NY with 2 other members. I am the managing member and the other 2 will not participate in management issues.

I understand I am subject to self employment [SE] taxes and they are not, but is this done only after profits/losses are distributed?

If the business has no net income, does that mean I pay no self-employment taxes?

I hope I did this the right way in leaving this question here and not posting a comment on line to you answer. This is my first time doing something like this and I do not know the "proper" procedures.

Again, thank you for you help.
Rhonda ... Bronx, NY


In a typical partnership, several people with different complementary skills get together to form a business. Rhonda doesn't say what kind of business they have formed so let's make one up to facilitate my examples. Since there are so many IT folks out there, I'll give Rhonda an IT business.

If all three participate in this business then they are all general partners. If they are equal partners each will share in 1/3 of the loss or 1/3 of the profit of the partnership. If the partnership has gross income of $50,000 and expenses of $20,000 then each would have income of $10,000 subject to income tax and SE tax. If the partnership had no profit, then there is no income or SE tax liability.

Profit is another way of saying net income -- that's gross income minus expenses -- and each partner will receive a partnership K-1 at year-end stating income and whether it is subject to SE tax or not.

An alternate scenario has Rhonda as the only one with technical skills and the only one to work for the partnership. Only her income is subject to SE tax. Partner #2 did nothing for the business other than contribute money and partner #3 did nothing for the business other than contribute equipment. Their partnership income was taxable but not subject to SE tax.

To recap: Simply not being part of management does not make the other partners exempt from SE tax. Their relationship to the partnership must be limited. That means they do not work in the partnership. For their portion of the partnership profit they may do things such as:
** Put in money
** Contribute equipment
** Loan a name or reputation
** Perform a specific service -- not related to the nature of the business, for instance -- legal or accounting, or logo design for which they'd receive a Form 1099-MISC from the partnership.

One last note: Of course, Rhonda should not set up an LLC and form a partnership without guidance from her tax pro.

June Walker

I am an LLC. How do I pay taxes?

Hello June,

I am glad I discovered your blog. Already I learned a great deal! Anyway, I am starting an LLC in NY with 2 other members and am a bit concerned about messing up with estimated & self employment taxes. I am the managing member and the other 2 will not participate in management issues. It is a brand new business so how will estimated taxes be calculated?

Also, I understand I am subject to self employment taxes and they should not, but is this done only after profits/losses are distributed? If the business has no net income, does that mean I pay no self-employment taxes?

Thank you for any help you can give, I just want to get this right. Rhonda in the Bronx :)


Hi Rhonda,

I, too, am glad that you discovered my blog!

You say you are an LLC with other people. I assume from that you have formed a partnership. I cannot say it frequently enough so i will take another opportunity here: An LLC [Limited Liability Company] is a legal entity and can be a sole proprietorship, partnership or corporation. More info here LLC? Incorporate?

As a self-employed you -- and your partners -- [I am not sure what you mean by "they should not"] must pay federal and state income tax and self-employment [SE] tax. Depending on your income amount you may also be subject to New York City Unincorporated Business Tax. SE tax is based upon your business net profit. No profit means no SE tax. Income tax is based upon your net profit and all your other income as well. Taxes are explained on my website here Taxes: Which ones and how much do I pay?

You may have to pay estimated taxes. It depends on business and all other income and also how much may be withheld from your spouse's income, or via a pension, etc. How much and when to pay estimated tax is explained in this blog post Estimated Taxes .

Wish you much success!
June