Is There Such a Thing as an "Informal Partnership"?

Can two people run a family child care business out of a home on an informal basis? Meaning, can they decide to split the income and expenses and file separate tax forms as self-employed or independent contractors? I hear about this a lot. The two people may call themselves a partnership or they may say they are running two separate businesses. Sometimes the two people are mother and daughter, or husband and wife, or two friends.

Although an "informal partnership" sounds like a good idea, it's not possible.

The IRS will not accept this. Your options are to operate as a formal partnership (and follow the many rules of a partnership), a sole proprietorship (self-employed) where the owner of the home hires the other person as her employee, a single person Limited Liability Company (LLC) or a corporation.

That’s it. There is no such thing as an "informal partnership."

A formal partnership is an unincorporated business run by two or more people who share the profit and loss. 

What are the consequences of operating as a partnership? You must file a partnership agreement with your state secretary of state office that spells out the rights and responsibilities of each partner. You can split the income and expenses however you want between you and your partner. Either partner can end the partnership at any time.

Each partner is legally liable for the actions of the other partner. You and your partner must file partnership tax forms and there are no tax savings over a sole proprietor. In face, you will lose some of your house deductions if you form a partnership. The partnership would have to pay rent to the owner of the home and the owner would report the rent as income on Schedule E.

Not all house expenses can be deducted on Schedule E (house depreciation being the major one). The record keeping rules for a partnership are more complex than a sole proprietor as you must keep your business and personal expenses completely separate. Any items that the partnership purchases are the property of the business, not the partners individually. This requirement is particularly difficult to meet because providers buy so many items that are used by their business and their family.

As you can see, there aren’t really many benefits of forming a partnership other than making each person responsible for the business.

Forming a partnership with your husband makes no sense. Have him work for free or hire him as an employee.

There are many complex tax and legal issues when deciding to operate your business other than as a sole proprietorship (another name for self-employed). I strongly recommend providers consult with a tax preparer and lawyer before taking this step.

What’s a better alternative than a formal partnership? The best option is to be a sole proprietor and hire your friend to be your employee. The person who owns the house where the child care is offered should always be the employer so they can continue to deduct all house-related expenses.

I’ve written about the pros and cons these business structures at length in my book Family Child Care Legal & Insurance Guide. 

Tom Copeland - www.tomcopelandblog.com

Image credit: https://pxhere.com/en/photo/1442025

For more information, see my book Family Child Care Legal and Insurance Guide.