Your Partnership Income Tax Questions Answered
What is a Partnership?
A partnership is a business owned by several individuals who have signed a partnership agreement and have invested in the business. There are various types of partnerships, but all pay income tax in the same way.
Now for the details:
How Are Partnerships Taxed?
A limited liability company (LLC) with more than one owner (called "members") is usually taxed as a partnership because the IRS does not recognize LLC's as business entities for tax purposes. (An LLC may also elect to be taxed as a corporation or S corporation.)
A single-member LLC (with only one owner) is taxed as a sole proprietorship, not a partnership. The single-member LLC business income is reported on Schedule C of the person's personal tax return.
When are Partnership Income Tax Returns Due?
Form 1065 and the individual Schedule K-1's are due March 15 of the year following the tax year. (This date was changed in 2016, for the 2017 tax year and beyond.) If March 15 falls on a weekend or holiday, the due date is the next business day.
See this article about Due Dates for Business Taxes for the exact due dates for the current tax year.
How Do I File a Partnership income Tax Return?
A partnership itself does not pay income taxes directly to the Internal Revenue Service. The partnership files an information return on IRS Form 1065. This form is similar to other business tax forms.
- The first part reports the income of the partnership, including the calculation of cost of goods sold if the partnership sells products.
- The second part lists deductions for business expenses.
- Line 22 shows ordinary income (net income) for the partnership (income minus deductions).
- The last part calculates taxes due.
Read more about the detailed information about the documents and files needed for your tax preparer.
How Do I File Income Tax as a Partner?
Partners in a partnership are not paid a salary as employees; they are owners and each partner receives money each year based on their share of the total ownership of the partnership. The individual partner share is determined by the partnership agreement.
Doing calculations on partner income and including that information in the partner's income tax return is another two-step process.
Step 1: Preparation of Partner's Schedule K-1
Along with the partnership information return on Form 1065, the tax preparer also prepares a Schedule K-1 for each partner, which breaks down the partnership income and share of that income for that partner, along with other information. The Schedule K-1 is filed with the partner's personal income tax return, and the amount of loss or income is included along with the partner's other income.
Schedule K-1 is a complicated document. It includes:
- Information about the partner
- Information about changes in the partner's capital account during the year
- Partner's share of a list of income and deductions for the partnership.
Schedule K-1 also includes a calculation of the adjustments made to the partner's basis in the partnership. Basis is adjusted each year to reflect changes in the partner's contributions, and distributive share of the partnership's taxable and nontaxable income for the year (including depletion, which is similar to depreciation for natural resources).
See Partner's Instructions for Schedule K-1 (Form 1065) for more details.
Step 2: Including Schedule K-1 Information on the Partner's Income Tax Return
For most partners in partnerships, totals in Schedule K-1 get included on Schedule E of the partner's income tax return (usually Form 1040). Part II of Schedule E is "Income or Loss From Partnerships and S Corporations." In this section, the partner must report partnership income and loss for the year.
The information from Schedule E is then included on the main part of the partner's Form 1040 to calculate the total tax owed for that individual.
Schedule E is another complicated return. See the Instructions for Schedule E for more details.
This is just a brief overview of the way partner income tax is determined. As you can see, this process is complicated. Get the help of a tax professional to prepare partnership and partner tax returns.
How Does My Partnership Type Affect My Taxes?
On Schedule E you will see different sections for active and passive partners (also called limited and general partners. Passive partners are those who don't play an active part in managing the business, and if the partnership has a loss, that loss might be limited.
There are a variety of ways partners can set up their shares of ownership in the partnership. Some partners may not be share-holding, but most do have shares. Some partnerships give a greater share to a general partner who has additional responsibilities, but sometimes this person is paid a salary as an employee.
How to File an Extension for a Partnership Tax Return
You must file by the due date for the tax return, using IRS Form 7004. The application is for six months, so you must file your tax return by September 15.
Filing an extension for a tax return doesn't include extending the payment. To avoid fines and penalties, you must pay a substantial part of your taxes by the original tax due date.
Partners and Self-Employment Tax
The partners must also pay self-employment tax (Social Security/Medicare) based on their share of profits (not losses) each year. Line 14 on a partner's Schedule K-1 shows income from self-employment. This is the figure used to calculate the partner's self-employment tax on Schedule SE. The information from this calculation is added to the partner's other tax liability on the individual's tax return. if the partnership doesn't have income, no self-employment tax is due.
Information Needed to File a Partnership Tax Return
To file your partnership's federal income tax return you will several documents:
- A copy of your end-of-year Profit and Loss (Income) Statement for the partnership. In addition, you will need detail and totals on all the sources of income and types of expenses paid by the partnership during the year.
- A copy of your end-of-year Balance Sheet, details on all the property you purchased during the year, for depreciation calculation purposes.
- Listing of all of the shares of each partner and how the profits or losses are to be shared by the partners.