Q: Informal Profit Share Agreement Taxes

A: When it comes to reporting income from an informal profit-sharing agreement for tax purposes, it's important to ensure that both parties report their respective shares of the profits accurately on their tax returns. Here are some steps to consider:

1. Documentation: Even if the agreement is informal, it's crucial to have a written record of the terms, including the percentage of profits each party is entitled to and any other relevant details. This documentation can help support the income reported on tax returns.

2. Form 1099-MISC: If the individual in Tennessee paid $600 or more to the partner in California during the tax year, they should issue a Form 1099-MISC to report the income. The partner in California would then report this income on their tax return.

3. Self-Employment Income: If the profit-sharing arrangement is not structured as an employer-employee relationship, the income may be considered self-employment income. In this case, each party would report their share of the profits on Schedule C (Form 1040) and pay self-employment taxes (Social Security and Medicare taxes) on the income.

4. Partnership Tax Return: If the arrangement is considered a partnership for tax purposes, the partnership may need to file Form 1065 (U.S. Return of Partnership Income) and issue Schedule K-1 to each partner, showing their share of the partnership's income, deductions, and credits.

5. State Tax Returns: Since the individuals are in different states, they will need to follow the tax laws of their respective states. The partner in California may need to report the income on a California state tax return, even if the income was earned from a partnership with someone in Tennessee.

Given the complexity of the situation, it's highly recommended to consult with a tax professional who can provide guidance tailored to the specific circumstances of the informal profit-sharing agreement and ensure compliance with federal and state tax laws.