Is Form 1065 Necessary for Partnerships Between Spouses?

June 24, 2008 — 1,638 views  
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Where a partnership is owned entirely by a husband and wife who file a joint return, there has been the question of whether a Form 1065 for the partnership is necessary. In the Small Business and Work Opportunity Tax Act of 2007, signed into law in May 2007, Congress added section 761(f) to address joint ventures between spouses who file joint returns, effective for years beginning after Dec. 31, 2006.

Section 761(f) provides that a Form 1065 will not be required for a qualified joint venture. A qualified joint venture is any joint venture if: (1) the venture conducts a business, (2) the only members are a husband and wife, (3) both spouses participate in such business and (4) both spouses elect to be a qualified joint venture. In such case: (1) the venture will not be treated as a partnership, (2) the income, expenses, etc., must be divided between the spouses based on their ownership interest and (3) each spouse takes such spouse's share as items attributable to a sole proprietorship.

No regulations have been issued for section 761(f), but the instructions to Form 1065, page 2 state that no formal election is necessary and not filing a partnership return and reporting the income on Schedule C, C-EZ, or F of the taxpayers' form 1040 is sufficient. The instructions, but not section 761(f), also state that once an election is made, it cannot be revoked without IRS consent.

In addition to adding section 761(f), Congress made a change to the self-employment tax rules in section 1402. New paragraph (16) was added to section 1402(a) providing that if a taxpayer makes an election to be treated as a qualified joint venture, each spouse's share of the income or loss is to be taken into account in computing self-employment tax.

A possible trap for the unwary is that the exclusion from self-employment tax for rental income and loss does NOT apply. Thus, by not filing a Form 1065, the rental income from the venture will be subject to self-employment tax. On the other hand, a net rental loss will reduce other self-employment income. Therefore, for 2007 spouses should carefully consider whether to file a Form 1065 as their self-employment taxable income could be impacted.

As noted above, if an election is made, the consent of the IRS must be obtained to revoke the election. However, possibly the election could be revoked by (1) admitting another member to the joint venture, (2) transferring the entire interest of one spouse to the other or (3) by transferring the interests to an S or C corporation.

Grant Thornton LLP