If you are part of a business partnership, you should be aware of the unique tax reporting requirements for this type of company. They are different from both sole proprietorships and corporations and in some ways reflect a combined approach.
Partnership taxes involve two steps:
- The partnership itself reports its total income and provides forms to the partners.
- Next, the partners must report this information and pay taxes on their share of the business income when filing their individual annual tax returns with the IRS.
In most cases, partnerships will work with an accountant or tax preparer to go through their documents and prepare their tax returns.
Some may use online tax software, or they could work with specialized online accountants like those at Picnic Tax.
In either case, however, you’ll need to prepare the partnership’s records and documents in advance so that your accountant can produce the full report needed to prepare your tax returns.
How do partnerships file their federal income taxes?
Partnerships must use IRS Form 1065, the US Return of Partnership Income, to report their annual income to the federal government.
Unlike other types of tax forms, however, the partnership does not need to pay the IRS any taxes that are due as a result of its income.
Instead, the partners or members of the LLC have the responsibility for paying the taxes due as part of their personal tax returns.
The partnership agreement determines what share of income and losses is held by each partner in the business.
Form 1065 is essentially an information return that is accompanied by the distribution of a Schedule K-1 to each partner. This document contains that partner’s share of the company’s profits or losses over the tax year in question.
What do you need to prepare a partnership tax return?
For one thing, coffee. Just kidding (kinda).
In order to ensure your Form 1065 is completed properly, a tax preparer will need your regular, year-end financial statements that are used for your business. This includes:
- A profit and loss statement
- A ledger of revenues and expenses
- Any other documents that demonstrate money earned and spent through your partnership
These documents will help your tax preparer understand the net income that the partnership took in over the year. If the business ran at a loss over that period, this will also be reflected through the financial documents.
Just as with individuals filing their tax returns, partnerships may have deductible expenses. Receipts that document these expenses should also be provided so that they can be entered in accordance with the Form 1065 instructions provided by the IRS.
Your tax preparer should have documentation of where your income came from and where you accumulated expenses to make sure that these items are properly documented for the IRS.
To help out with this, you might consider providing a balance sheet from the beginning and end of the tax year to illustrate the overall change in the partnership’s financial position during that time.
The Form 1065 instructions provide specific information for completing the document. It will also need basic identifying information such as the partnership’s:
- Employer Identification Number (EIN)
- Date of formation
- Business code
- Type of accounting method (cash or accrual)
If the partnership is engaged in the sale of goods or products, you will also need to provide details that enable the calculation of the cost of goods sold, which encompasses the value of inventory held at the beginning and end of the year as well as items purchased for inventory during the year.
What are deductible partnership expenses?
Like other types of businesses, partnerships have a number of deductible expenses. This is money that you can subtract from your overall income to lower the amount of money you are being taxed on.
Make sure to provide documentation for all of these expenses so that your partners’ tax burden is minimized to the fullest extent possible. These deductible expenses can include the following:
- Rent for business premises
- Maintenance and repairs
- Fees, permits, licenses and non-federal taxes
- Depreciation for business assets
- Retirement plan expenses for employees and partners
- Other employee benefit programs
- Salaries for employees. Please note that this does not include all payments made to partners, although guaranteed payments to partners may be deductible.
In order to properly calculate the depreciation of business assets like machinery, vehicles and similar items, make sure to keep proper records of when you purchased these items, how much you paid and their current condition.
What about Schedule K-1?
Schedule K-1 forms are distributed to each partner as part of the Form 1065 filed by the partnership as a whole.
Since a partnership passes its income or losses through to the individual partners, this document is essential for each partner to report their share on their taxes.
In most cases, you will receive an IRS Schedule K-1 from the partnership’s accountant. If you are a partner in a business, you must attach this document to your personal Form 1040 when filing your annual tax return.
You can expect to receive this schedule if you are part of a general partnership, limited partnership, LLC that has chosen partnership taxation or a limited liability partnership.
Partners do not necessarily share equally in profits and losses. In some cases, if partners do not take home the income but instead invest it back into the company, they may not have income at all to report as part of this schedule.
Partnership taxation can be flexible according to the situation, but it is important for them to be well-documented in case of IRS scrutiny.
How is a K-1 different than a 1099?
While a K-1 and a 1099 both involve self-employment income, they are different.
A 1099 form reflects income paid by other businesses to a contractor, vendor or freelancer, while a K-1 reflects income for a partner from a business that they co-own.
If the partnership provides services to other companies, the partnership may receive 1099 forms to include as part of their IRS Form 1065. If you also receive other personal freelance income outside of the partnership, you may have both 1099 income and K-1 income to report on your Form 1040.
As with other types of self-employment income, you may need to pay self-employment tax on the money that you earned from the partnership.
However, if you are a limited partner, only your guaranteed payments for services delivered are considered to be self-employment income. Other types of income, like your distributed share of partnership earnings, may not be subject to self-employment taxes.
Your accountant may provide more detailed information on how your partnership affects your self-employment tax obligations, which are separate from and in addition to income taxes.
What information is included in a Schedule K-1?
This document will include:
- The partnership’s EIN
- The parternship’s contact information
- The IRS filing center
- Information on whether or not the partnership is publicly traded.
- The partner’s individual tax ID number, whether that is a TIN, EIN or social security number
- The status of the partner and personal identifying information
- The share you have as a partner in the overall capital, profits and losses of the partnership during the year
These sums are allocated based on the partnership agreement, which can be revised by agreement of the partners at any time.
As we’e stated, partners do not need to have equal shares in the firm. Changing percentages of the partnership are also included in the form, with beginning and ending columns on IRS Schedule K-1 indicating that partner’s share at the start and end of the tax year.
If you have a share of partnership liabilities, this will also be included on the form, including recourse debts, for which you have agreed to be personally liable; it will also include the amount of capital you have in the business and any changes made during the year.
What detailed income information must you provide on your IRS K-1?
On the K-1 you attach to your Form 1040, you will need to provide detailed information about different types of income and losses throughout the year, including:
- Ordinary business income
- Real estate and rental income
- Guaranteed payments
- Capital gains
You can also use the IRS Schedule K-1 instructions to report your share of partnership deductions, including cash and non-cash contributions, benefits or retirement funds.
Self-employment earnings or losses will also be specified, and you will have a chance to claim your share of any credits for which your partnership is eligible.
When can you expect your K-1?
As a partnership, the company must file its IRS Form 1065 before March 15 of the next year, although it can file for a six-month extension. At the same time, the company must also issue K-1 schedules for each partner.
This gives each partner around one month to file their own forms before the April 15 deadline for personal tax returns.
Partnership taxes can be complicated, and they can occupy a great deal of your valuable business time. Picnic Tax can match you with online accountants with experience in partnership tax returns that can ensure that your tax returns are timely, complete and accurate – and that you claim all of the deductions and credits that you are entitled to receive.
This easy system can save you hours or days of time, all at a fixed flat rate that you know in advance. Contact Picnic Tax today to learn more.