For the Taxman, Even Informal Partnerships Have a Life of Their Own
It's tempting to file as two individuals. You may only cheat yourselves
Q: I'm starting a home-based sewing business with another person, and we're unsure how to set up the company. How do we file income taxes: jointly or separately?
A: When two people go into business together, they've formed a partnership -- whether they agree orally or draw up legal documents to prove it. If you and your partner participate jointly in the business and divide the income, your company is truly a separate entity for tax purposes, whether you incorporate it or not. Even though you may be working out of one of your homes, you should not declare income from the business on an Internal Revenue Service Form 1040, Schedule C, which is for home-based businesses operated by an individual. That might save you some paperwork in the short-term, but it could come back to haunt you in a tax audit.
"When they have informal partnerships, a lot of people try to get away with splitting the income 50-50 and reporting as two separate, home-based businesses," says David Flamer, of accounting firm Lasher, Flamer & Associates in Woodland Hills, Calif. But an auditor might hit you with penalties for a delinquent return if you fail to file for a partnership -- even if you don't owe any additional taxes.
One of the first steps in setting up a business is to apply for an employer identification number. The form (SS-4) is available from the IRS's Web site (www.irs.gov) under "Forms and Publications." Check with local authorities to see if you need a license to operate a home-based businesses in your city. You'll probably also need to file a local fictitious name statement, known as a DBA ("doing business as..."), so that you can open a business checking account and accept payments in the company name. At tax time, you or your accountant should file Form 1065, listing the income and expenses of the partnership.
One of the attached schedules splits the income between the partners, Flamer says. You deduct common business expenses such as office supplies, material, sewing machines, and repairs from the partnership income. Tax treatment of home offices is an area that requires professional tax advice. If you run the company from one partner's home, you can deduct expenses for maintaining the office from that partner's income on his or her personal return, he says. If home-office expenses become significant, you may want to charge rent to the partnership for the use of the space. Home owners (not renters) can also depreciate the office.
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