When multiple people own a business together, they often form a legal partnership — making them shared owners in the financial future of their business. If you are an investor in a partnership (or run a business organized as a partnership), you may want more information on how to file your tax returns correctly.
There are several types of partnerships, including general partnerships, limited partnerships and Limited Liability Partnerships or LLPs. While a Limited Liability Corporation (LLC) is not a partnership, LLCs with multiple members file tax returns the same way that partnerships file tax returns.
Partnership taxes involve two steps:
- First, the partnership itself must file its tax returns and report its income and distributions.
- Second, each partner must report their share of income or losses on their tax returns.
Partnerships do not pay taxes directly. Instead, the members of the partnership each pay taxes on the income they received from the business.
IRS Form 1065: Federal Income Taxes for Partnerships
This IRS form, also called the US Return of Partnership Income, is used to calculate partnership tax returns. It is used by all partnerships and LLCs to report their income annually.
At the same time that the partnership files this form, it will also provide each partner with a Schedule K-1 to use when filing their income taxes. This schedule shows each partner’s portion of the partnership’s profits or losses for the tax year.
When Partnership Taxes Are Due
Income tax returns for partnerships must be submitted to the IRS on March 15 of the year following the tax year.
Partnerships must file Form 1065 as well as Schedule K-1 documents for the individual partnership members. If you are used to individual taxes only, you will notice that business taxes often have different deadlines.
When March 15 falls on a holiday or a weekend date, the tax returns are due on the next business day.
Seeking an Extension
If a company is unable to complete its partnership tax return prior to March 15, the company must file IRS Form 7004 to seek an automatic extension of six months. In this case, the company must file before September 15.
It should be noted that this does not excuse the partners of their responsibility to report their income from the year and pay their own income taxes on that sum in a timely fashion. If the partnership has not provided you with a final K-1 in time for the April 15 personal tax deadline, you should file a personal tax extension so you can file in the fall after the K-1 has been delivered.
How To File Partnership Income Taxes
Partnerships do not directly submit taxes to the IRS. Instead, the partnership completes the required IRS form, similar to others used by businesses submitting annual tax returns. Form 1065 gathers information such as:
- Partnership income: If your partnership sells items, this includes calculations of the cost of goods sold as well as overall income.
- Business expenses: The second part of the form reports claimed deductions to cover partnership business expenses.
- Net income: On Line 22 of the form, indicate the partnership’s net income, with total income minus deductions.
- Taxes due: The final section involves the calculation of taxes owed.
Calculating Business Expenses
Partnerships may face a significant amount of business expenses throughout the year, and many are deductible. Claiming business expenses properly can reduce the tax burden on the partners. Some of the deductible expenses include salaries and wages for employees, maintenance costs, rent, non-federal taxes, licensing fees, depreciation, retirement funds and employee benefit programs.
Background Documents for Preparing Tax Returns for a Partnership
If you are an owner of a partnership and looking to prepare your partnership taxes, you will need some documents on hand. Get them ready for your tax preparer or online accountant to save additional time. Some of these important references include:
- Partnership details: You or your tax preparer will need key information, like the founding date of the partnership, the NAICS code or business code, and the Employer ID Number or EIN.
- Profit and loss statement or income statement: This should be calculated at the end of the year for the partnership. In addition to the overall statement, you will need to include more information about the partnership’s income sources and the types of expenses it paid out during the year.
- Gross receipts: In addition to direct income, you should have documentation of discounts and gifts to the partnership on hand.
- Balance sheet: This will provide details on partnership property purchases and allow you to calculate depreciation for reporting on the return. Make sure to have details about assets belonging to the partnership, including real estate and vehicles.
- Accounting method: If you use a cash method or an accrual method, it will affect how income and expenses are reported.
- Cost of goods sold: This information, including inventory value and purchases, is important to calculating income from the sale of products.
- Partnership agreement: This contains share information for each partner and describes how profits and losses should be attributed to each partner.
Paying Income Taxes as a Business Partner
Each partner is an owner of a share of the overall partnership. The income that they take home from this ownership stake is different from that earned by an employee. (In some cases, a partner may also be hired by the company and paid a salary, however. ) Each owner takes home a portion of the partnership’s profits each year, based on the percentage of the partnership that they own. Each partner’s share is specified in the partnership agreement used to found the business.
Therefore, each partner requires a Schedule K-1. This document reports the total income of the partnership and the share that belongs to the partner in question. The schedule is attached to the partner’s personal income tax return, and partnership losses and income are calculated together with the partner’s other sources of income.
Your Schedule K-1 will contain a range of specific information, including the following:
- Details about the partner
- Changes in the capital account of the specified partner during the year
- Share of income and deductions from the overall partnership
- Calculation of changes to the partner’s share in the partnership
Every year, partnership basis is calculated and adjusted. This reflects changes in each partner’s contributions and affects the share of income that each partner takes away from the company.
Schedule K-1 Details On Your Income Taxes
Income from Schedule K-1 is typically included as part of Schedule E attached to a Form 1040 filed for the individual partner’s income taxes. As part of Schedule E, taxpayers report income and losses from S Corporations and partnerships; the information from the Schedule K-1 can be included here alongside any other partnerships in which the individual is involved. The Schedule E data is then included in the total Form 1040 for completed tax calculations.
Partnership Types and Tax Liabilities
When completing Schedule E of your personal Form 1040 tax return, you will see separate areas for input from active or passive partners, another name for limited and general partners. If you are a passive partner, you do not play an active role in the company, while if you are an active partner, you are involved on an ongoing basis. Passive partners may be restricted in the losses they can claim if the partnership takes a loss for the year.
If you are a passive partner, you do not play an active role in the company, while if you are an active partner, you are involved on an ongoing basis. Passive partners may be restricted in the losses they can claim if the partnership takes a loss for the year.
When setting up a partnership, partners can divide their ownership shares in many ways. It is even possible to include partners who do not own shares. In some cases, a partner may be paid a salary for specific work they perform in addition to their regular share from the partnership. This salary would be reported like other earned income on a tax return, rather than as part of the ownership income from a partnership.
Self-Employment Taxes and Partnership Income
Each partner also is required to pay self-employment tax on the portion of profits taken in each year. On Schedule K-1, Line 14 includes self-employment income. This number should be transferred to Schedule SE of Form 1040 to calculate self-employment taxes, which go to cover Social Security and Medicare tax obligations. If the partnership does not take in a profit that year or has losses, the partner does not owe additional self-employment taxes.
Get Help With Your Partnership Tax Returns
Partnership taxes can be complicated, and all of the partners’ individual tax liabilities may be affected by the accuracy of your annual returns. A professional tax preparer or online accountant has the skills and information needed to produce correct, verified partnership returns in a timely fashion.
Picnic Tax connects you with professional accountants without having to make an in-person appointment. You can upload your information online through our secure server and get a clear price in advance to prepare your partnership taxes. Contact us today to find out more about how our online service can help you produce accurate, reliable partnership returns quickly.