Small Business

Cementing the Partnership


By Karen E. Klein Q: My husband has a music company that we founded in 1997 as a partnership, but we've been filing taxes over the years as if the company were a sole proprietorship. I'd like to remedy the situation. Can we just start filing as a partnership now?

---- P.P., Wausaukee, Wis.

A: You don't say whether you established a formal partnership for the company four years ago, including drawing up a partnership agreement, having an employer-identification number assigned, and setting up a separate bank account. If you actually did all that work to create the business entity, you should probably have a tax preparer amend your individual returns and file IRS Form 1065 partnership returns from now on, experts say.

If you haven't arranged a formal partnership, you'll need to file an application for an employer-identification number, says Lee Reicher, a partner in the Los Angeles law firm of Reish & Luftman. A sole proprietorship is identified by the owner's social security number, but because a partnership has more than one owner, it is a separate taxable entity and must have its own identification number. "Use Form SS-4 to apply for a partnership-identification number now, then use that number on your tax return to identify the business," Reicher says.

Since you're married, and the income from either a sole proprietorship or a partnership goes into the same income pool, your tax liability should be unchanged. Says Reicher: "It's kind of a no-harm, no-foul situation."

STRUCTURAL ANALYSIS. If you file jointly, as most married couples do, and you did not initially set up a formal partnership, you might want to act from the simple premise that the partnership has not actually been formed, especially if you prepare your own taxes and don't want to complicate matters or hire a tax professional. You can simply list yourself and your husband as 50-50 owners on your sole-proprietorship form (Schedule C) at tax time. "Make sure that each [has] their separate self-employment tax [social-security tax] on the income, and the total will be recognized for income-tax purposes," says David Flamer, a Woodland Hills (Calif.)-based accountant.

As long as you're revisiting the question of your business entity, you may want to consult a professional and get some advice on the best structure for your company in the future, says Mary Lou Pier, a Chicago accountant and small business tax specialist. "A limited liability company or an S corporation may be a better way to go," Pier says, since those structures will afford some relief from personal liability in the event of a lawsuit. For more information, and to download forms,

visit the IRS Web site at www.irs.gov. Have a question about running your business? Ask our small-business experts. Send us an e-mail at smartanswers@businessweek.com, or write to Smart Answers, BW Online, 6th Floor, 2 Penn Plaza, New York, NY 10121. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.


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