Filing small business taxes is often one the most dreaded exercises people face each year. The IRS code is unbelievably detailed, and it seems to grow larger and more confusing every year. Unfortunately, there’s no way to legally avoid the process. Fortunately, if you’re willing to spend a little money, you can hire a professional to help make sense of all the terminology, rules and forms – including Schedule K-1 (Form 1065).
Tax Filings – Partnership (Form 1065) vs. Partner (Schedule K-1)
With regard to taxation, a partnership is structured as a “pass-through” legal entity. This means the partnership is not taxed directly; rather, all income is passed on to the underlying partners for taxation at the individual level. See how are partnerships taxed for further information.
At the partnership level, annual income is reported to the IRS via an informational return known as Form 1065. For each Form 1065 filing, a partnership is required to distribute Schedule K-1s to its various partners. The K-1s represent each partner’s proportional claim to the partnership’s income.
For example, if a partnership earns $1,000,000 of taxable income and has four equal partners, each partner will receive a K-1 that reports $250,000 of income on it.
$1,000,000 Partnership Income / 4 Equal Ownership Interests = $250,000 of Partner-level Income
When Might I Receive Schedule K-1 (Form 1065)?
Generally, anyone who is a member of a partnership, regardless of whether it’s structured as a general partnership or a limited partnership, will receive a Schedule K-1. For business operating on a calendar year basis, the K-1s must distributed on or before March 15 of each year. For businesses that utilize an alternative fiscal year, the K-1s must distributed no later than the third month after the end of the fiscal year.
If you are a member of multiple partnerships, you will receive multiple Schedule K-1s. Copies of all forms are simultaneously provided to the IRS and pertinent state and local tax departments.
If you receive an erroneous Schedule K-1, immediately contact the partnership to rectify the situation. Doing so will allow you to avoid filing an incorrect tax return.
What Should I Do with Schedule K-1 (Form 1065)?
Generally, all financial information on a Schedule K-1 can impact your annual tax filing (Form 1040, see form 1040 schedule c instruction for more details). However, the income and deductions reported on your K-1(s) may not match the figures you report to the IRS. This is attributable to the myriad of IRS limitations and loss carry-forward allowances that can impact you from one year to the next.
Ultimately, it is the partner's responsibility to consider and apply all applicable rules. If you are unaware of the rules or unfamiliar with the information on a K-1, you should consult with a tax professional.
That said, if you’re a do-it-yourself type or someone that enjoys educational research, you can find the IRS’ prescriptive guidance at the following link: Instructions for Schedule K-1 (Form 1065). Additionally, in the section below, we offer an overview of the information reported on a Schedule K-1 (Form 1065).
What Information Is Reported on Schedule K-1 (Form 1065)?
Schedule K-1 (Form 1065) includes three distinct parts that are designed to report identifying information on the partnership, identifying information on the partner and financial data for the current tax year. Additional high-level details are described and illustrated below.
Part I - Information About the Partnership: This part contains basic information about the partnership, such as its employer’s identification number, name and address. This part also includes a field that specifies whether it’s a publicly traded partnership (PTP), which can impact the tax treatment of certain items reported elsewhere on the K-1.
Part II - Information About the Partner: This part contains information about the partner and his or her interest in the partnership. Beyond identifying information, such as social security number or tax identification number, this part includes a field that specifies whether the partner is a general partner or a limited partner and whether the partner’s share of the partnership’s liabilities is recourse or non-recourse. It also reports the partner's percentage claim on profits, losses and capital invested.
Part III - Partner’s Share of Current Year Income, Deductions, Credits, and Other Items: This part is used to report the partner’s share of the income, losses, deductions, credits and other items generated by the partnership for the current year. Ultimately, the information feeds other tax schedules and is used to calculate an individual’s aggregate tax obligation.