Husband-Wife Partnerships: The Tax Angles

When both members of a married couple participate in an unincorporated business venture, must it be treated as a husband-wife partnership for federal tax purposes? Answer: maybe, or maybe not. Figuring out the answer is important because it can have a huge impact on the couple’s self-employment tax situation.

Husband-wife partnerships must also file annual federal returns on Form 1065 along with the related Schedules K-1. As you know, partnership returns can be a pain. For these reasons, you generally want to avoid husband-wife partnership status when possible.

When Does the Husband-Wife Partnership Actually Exist for Tax Purposes?

Good question. As you can see from the preceding example, the self-employment tax can make the husband-wife partnership an expensive proposition. Of course, the IRS would love it if you had to treat it that way.

Not surprisingly, several IRS publications attempt to create the impression that involvement by both spouses in an unincorporated business activity usually creates a partnership for federal tax purposes.

IRS Publication 334 (Tax Guide for Small Business) says the following:

If you and your spouse jointly own and operate an unincorporated business and share in the profits and losses, you are partners in a partnership, whether or not you have a formal partnership agreement.

In other words, you don’t have to believe that you have a husband-wife partnership to have a husband-wife partnership for tax purposes.

Similarly, IRS Publication 541 (Partnerships) says:

If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. If so, they should report income or loss from the business on Form 1065.

But in many (if not most) cases, the IRS will have a tough time prevailing on the husband-wife partnership issue. Consider the following direct quote from IRS Private Letter Ruling 8742007:

Whether parties have formed a joint venture is a question of fact to be determined by reference to the same principles that govern the question of whether persons have formed a partnership which is to be accorded recognition for tax purposes. Therefore, while all circumstances are to be considered, the essential question is whether the parties intended to, and did in fact, join together for the present conduct of an undertaking or enterprise.

The following factors, none of which is conclusive, are evidence of this intent:

1. the agreement of the parties and their conduct in executing its terms;
2. the contributions, if any, that each party makes to the venture;
3. control over the income and capital of the venture and the right to make withdrawals;
4. whether the parties are co-proprietors who share in net profits and who have an obligation to share losses; and
5. whether the business was conducted in the joint names of the parties and was represented to be a partnership.

In many (if not most) real-life situations where both spouses have some involvement in an activity that has been treated as a sole proprietorship, or in an activity that has been operated using a disregarded single-member LLC that has been treated as a sole proprietorship for tax purposes, only some of the five factors listed in Private Letter Ruling 8742007 will be present. Therefore, in many such cases, the IRS may not succeed in making the husband-wife partnership argument.

Regardless of the presence or absence of the other factors listed above, the husband-wife partnership (LLC) argument is especially weak when (1) the spouses have no discernible partnership agreement and (2) the business has not been represented as a partnership to third parties (for example, to banks and customers).

• By Leon Clinton
• April 20, 2020

COVID-19: Tax Season Delayed Until July 15 – Wait or File Now?

As you know, the COVID-19 pandemic has shut down much activity in the United States.

The IRS decided to use its authority in a national emergency to postpone certain tax return filings and payments. This change affects every one of you, and the rules are tricky—after all, this is tax law.

We’ll explain who gets relief; what the IRS postponed; and perhaps more important, what wasn’t postponed. We’ll also tell you whether you should file regardless of the postponement.

Who Qualifies?

First, to qualify for postponement, you must have a tax return that is due on April 15, 2020. In general, the returns due on April 15 include the following:

• An individual filing a Form 1040 series return
• A trust or estate filing Form 1041
• A partnership filing Form 1065
• A corporation filing a Form 1120 series return

In its FAQ, the IRS did not include the Form 1065 for partnerships or the Form 1120S for S corporations when it listed the forms available for relief.

That’s because most partnerships and S corporations have calendar-year returns, making the 2019 tax return due March 15, 2020. But if you have a fiscal-year partnership or S corporation with a due date of April 15, 2020, it should qualify for relief under the official guidance.

Second, you must have one of the following due on April 15, 2020:

• Tax year 2019 federal income tax return
• Tax year 2019 federal income tax payment
• Tax year 2020 federal estimated income tax payment

This grant of relief does not apply to

• federal payroll taxes, including federal tax deposits, and
• federal information returns.

Federal Tax Return Filing Deadline

If you qualify for relief, your 2019 federal income tax return is now due July 15, 2020.

You do not have to file an extension on Form 4868 or Form 7004 or contact the IRS to get the automatic postponement to July 15, 2020.

If you need additional time beyond July 15, 2020, to file your tax return, you can file Form 4868 or Form 7004 on or before July 15, 2020, and get an automatic extension to your normal extension due date:

• September 30 for Form 1041
• October 15 for Forms 1040 and 1120

IRA, HSA, and Retirement Plan Payments

The COVID-19 grant of relief also postpones the following payment deadlines until July 15, 2020:

• 2019 individual retirement account (IRA) contribution
• 2019 health savings account (HSA) contribution
• 2019 employer qualified retirement plan contributions

The relief does not apply to federal information returns; therefore, if you have a tax return that is otherwise postponed, and you need to file an international information return with it, you need to file your tax return or extend by April 15, 2020, or June 15, 2020 (if outside the U.S.).

Examples of international information returns affected include the following:

• Form 8938, Statement of Specified Foreign Financial Assets
• Form 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations
• Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)

Tax Payment Deadline

If you qualify for the relief, your federal income tax payment is due July 15, 2020.

This payment postponement applies only to the following:

• 2019 income tax return balance-due payments
• 2020 income tax estimated tax payments that are due April 15, 2020

There is no limit to the deferred amounts. Earlier guidance provided a $10 million limit for C corporations and a $1 million limit for other taxpayers, but the IRS eliminated these limits in its updated guidance.

The relief does not provide for a waiver of 2020 estimated tax payment penalties for not making the payment on the normal schedule. But we’d expect the IRS to be generous in granting relief when the time comes to file your 2020 tax returns.

If you already filed your 2019 tax return and scheduled a direct debit payment, call the IRS e-file Payment Services 24/7 at 1-888-353-4537 to cancel your payment at least two business days prior to the payment date.

Example 1

Sarah, who is single, owes $10,000 on her 2019 Form 1040. She does not have a 2020 estimated tax payment requirement.

Sarah must

• file or extend her 2019 Form 1040 by July 15, 2020; and
• pay the $10,000 balance due for her 2019 Form 1040 by July 15, 2020 (even if she extends to October 15, she has to pay by July 15, 2020).

Example 2

Jake and Karen’s 2019 Form 1040 shows a refund of $1,500. They have a 2020 estimated tax payment requirement of $2,000 per quarter.

Jake and Karen must

• pay $2,000 for their second-quarter estimated tax payment by June 15, 2020 (yes, June 15—strange but true);
• file their 2019 Form 1040 or extend it by July 15, 2020; and
• pay $2,000 for their first-quarter estimated tax payment by July 15, 2020 (yes, the second quarter was due on June 15).

Example 3

Steve and Joan’s 2019 Form 1040 shows an estimated balance due of $1.1 million. They have a 2020 estimated tax payment requirement of $100,000 per quarter. Due to missing tax forms, they usually do not file until September.

Steve and Joan must

• pay $100,000 for their second-quarter estimated tax payment by June 15, 2020;
• file a Form 4868 by July 15, 2020, for their 2019 Form 1040, to request an extension until October 15, 2020;
• pay $100,000 for their first-quarter estimated tax payment by July 15, 2020; and
• pay $1.1 million for their 2019 Form 1040 balance due by July 15, 2020.

Should You Wait?

If your tax return shows a refund, file it as soon as possible—get your cash as quickly as you can.

If you have the cash and liquidity to make your tax payments on April 15, 2020, but keeping those payments in your bank account earns extra interest income, we see no reason you shouldn’t delay until July 15, 2020.

If you have problems with making timely estimated tax payments, we recommend you keep the normal schedule as long as you have the liquidity and cash to make the payments. We don’t want you to fall into bad habits and possibly create an unpayable balance due on your 2020 tax return.

Be safe and take care.

I’m always here to help you in any way I can. My direct line is 408-778-9651.

• By Leon Clinton
• April 15, 2020

COVID-19: CARES Act Allows $100,000 Tax-Free IRA Grab and Repay

COVID-19-Related Distributions from IRAs Get Tax-Favored Treatment

If you are an IRA owner who has been adversely affected by the COVID-19 pandemic, you are probably eligible to take tax-favored distributions from your IRA(s).

For brevity, let’s call these allowable COVID-19 distributions “CVDs.” They can add up to as much as $100,000. Eligible individuals can recontribute (repay) CVD amounts back into an IRA within three years of the withdrawal date and can treat the withdrawals and later recontributions as federal-income-tax-free IRA rollover transactions.

In effect, the CVD privilege allows you to borrow up to $100,000 from your IRA(s) and recontribute the amount(s) at any time up to three years later with no federal income tax consequences.

There are no income limits on the CVD privilege, and there are no restrictions on how you can use CVD money during the three-year recontribution period.

If you’re cash-strapped, use the money to pay bills and recontribute later when your financial situation has improved. Help your adult kids out. Pay down your HELOC. Do whatever you want with the money.

CVD Basics

Eligible individuals can take one or more CVDs, up to the $100,000 aggregate limit, and these can come from one or several IRAs. The three-year recontribution period for each CVD begins on the day after you receive it.

You can make recontributions in a lump sum or make multiple recontributions. You can recontribute to one or several IRAs, and they don’t have to be the same account(s) you took the CVD(s) from in the first place.

As long as you recontribute the entire CVD amount within the three-year window, the transactions are treated as tax-free IRA rollovers. If you’re under age 59 1/2, the dreaded 10 percent penalty tax that usually applies to early IRA withdrawals does not apply to CVDs.

If your spouse owns one or more IRAs in his or her own name, your spouse is apparently eligible for the same CVD privilege if he or she qualifies (see below).   

Do I Qualify for the CVD Privilege?

That’s a good question. Some IRA owners will clearly qualify, while others may have to wait for IRS guidance. For now, here’s what the CARES Act says.

A COVID-19-related distribution is a distribution of up to $100,000 from an eligible retirement plan, including an IRA, that is made on or after January 2, 2020, and before December 31, 2020, to an individual

• • who is diagnosed with COVID-19 by a test approved by the Centers for Disease Control and Prevention; or
• • whose spouse or dependent (generally a qualifying child or relative who receives more than half of his or her support from you) is diagnosed with COVID-19 by such a test; or
• • who experiences adverse financial consequences as a result of being quarantined, furloughed, laid off, or forced to reduce work hours due to COVID-19; or
• • who is unable to work because of a lack of child care due to COVID-19 and experiences adverse financial consequences as a result; or
• • who owns or operates a business that has closed or had operating hours reduced due to COVID-19, and who has experienced adverse financial consequences as a result; or
• • who has experienced adverse financial consequences due to other COVID-19-related factors to be specified in future IRS guidance.

We await IRS guidance on how to interpret the last two factors. We hope and trust that the guidance will be liberally skewed in favor of IRA owners. We shall see.

What If I Don’t Recontribute a CVD within the Three-Year Window?

Another good question. You will owe income tax on the CVD amount that you don’t recontribute within the three-year window, but you don’t have to worry about owing the 10 percent early withdrawal penalty tax if you are under age 59 1/2.

If you don’t repay, you can choose to spread the taxable amount equally over three years, apparently starting with 2020.

Example. Tomorrow you withdraw $90,000 from your IRA, and you don’t recontribute it and don’t elect out of the three-year spread; you have $30,000 of taxable income in years 1, 2, and 3.

Here it gets tricky, because the three-year recontribution window won’t close until sometime in 2023. Until then, it won’t be clear that you failed to take advantage of the tax-free CVD rollover deal.

So, you may have to amend a prior-year tax return to report some additional taxable income from the three-year spread. The language in the CARES Act does not address this issue, so the IRS will have to weigh in. Of course, the IRS may not be in a big hurry to issue guidance right now, because it has three years to mull it over.   

You also have the option of simply electing to report the taxable income from the CVD on your 2020 Form 1040. You won’t owe the 10 percent early withdrawal penalty tax if you are under age 59 1/2.

Can the One-IRA-Rollover-Per-Year Limitation Prevent Me from Taking Advantage of the CVD Deal?

Gee, you ask a lot of good questions. The answer is no, because when you recontribute CVD money within the three-year window, it is deemed to be done via a direct trustee-to-trustee transfer that is exempt from the one-IRA-rollover-per-year rule. So, no worries there.

Can I Take a CVD from My Company’s Tax-Favored Retirement Plan?

Yes, if your company allows it. The tax rules are similar to those that apply to CVDs taken from IRAs.

That said, employers and the IRS have lots of work to do to figure out the details for CVDs taken from employer-sponsored qualified retirement plans. Stay tuned for more information.        

More Good News: Retirement Account Required Minimum Distribution Rules Are Suspended for 2020

In normal times, after reaching the magic age, you must start taking annual required minimum distributions (RMDs) from traditional IRAs set up in your name (including SEP-IRA and SIMPLE-IRA accounts) and from tax-favored company retirement plan accounts. The magic age is 70 1/2 if you attained that age before 2020 or 72 if you attain age 70 1/2 after 2019.

And you must pay income tax on the taxable portion of your RMDs. Ugh!

Thankfully, the CARES Act suspends all RMDs that you would otherwise have to take in 2020.

The suspension applies equally to your initial RMD if you turned 70 1/2 last year and did not take that initial RMD last year (the initial RMD is actually for calendar year 2019). Before the CARES Act, the deadline for taking that initial RMD was April 1, 2020. Now, thanks to the CARES Act, you can put off any and all RMDs that you otherwise would have had to take this year. Good!

For 2021 and beyond, the RMD rules will be applied as if 2020 never happened. In other words, all the RMD deadlines will be pushed back by one year, and any deadlines that otherwise would have applied for 2020 will simply be ignored.

Takeaways

The CVD privilege can be a very helpful and very flexible tax-favored financial arrangement for eligible IRA owners.

• • You can get needed cash into your hands right now without incurring the early withdrawal penalties.
• • You can then recontribute the CVD amount anytime within the three-year window that will close sometime in 2023—depending on the date you take the CVD—to avoid any federal income tax hit.

The suspension of RMDs for this year helps your 2020 tax situation, because you avoid the tax hit on RMDs that you otherwise would have had to withdraw this year.

I love it when I can bring you good news. If you would like to discuss the COVID-19 changes to your IRA, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• April 6, 2020