What Is the Schedule K-1?
A Schedule K-1 is a tax document used to report the incomes, losses, and dividends of a business's partners or an S corporation's shareholders. The Schedule K-1 document is prepared for each individual partner and is included with the partner’s personal tax return. An S corporation reports activity on Form 1120S, while a partnership reports transactions on Form 1065.
Understanding the Schedule K-1
The tax code in the United States allows the use of certain pass-through taxation, which shifts tax liability from the entity (trust, corporation) to the individuals who have an interest in it. This is where the Schedule K-1 comes in.
- Business partners or S corporation shareholders use Schedule K-1 to report their incomes, losses, and dividends.
- The Schedule K-1 requires the partnership to track each partner’s basis in the partnership.
- A partner can earn several types of income on Schedule K-1.
While not filed with an individual partner’s tax return, the financial information posted to each partner’s Schedule K-1 is sent to the IRS with Form 1065. Income earned from partnerships is added to the partner’s other sources of income and entered in Form 1040.
The Schedule K-1 requires the partnership to track each partner’s basis in the partnership.
Factoring in Partnership Agreements
A partnership is defined as a contract between two or more people who decide to work together as partners. The rules of this business arrangement are stated in a partnership agreement. The partnership has at least one general partner (GP) who operates the partnership.
GPs are liable for their actions as partners and for the activities of other GPs in the partnership. Limited partners, on the other hand, are liable for the debts and obligations of the partnership based only on the amount of capital they contribute. The partnership agreement dictates how the partners share profits, which impacts the information on Schedule K-1.
The Schedule K-1 requires the partnership to track each partner’s basis in the partnership. Basis refers to a partner’s investment in the enterprise. A partner’s basis is increased by capital contributions and the partner’s share of income, while basis is reduced by a partner’s share of losses and any withdrawals.
Assume, for example, that a partner contributes $50,000 in cash and $30,000 in equipment to a partnership, and the partner’s share of income is $10,000 for the year. The total basis is $90,000, less any withdrawals taken by the partner.
The basis calculation is important because when the basis balance is zero, any additional payments to the partner are taxed as ordinary income. The basis calculation is reported on Schedule K-1 in the partner’s capital account analysis section.
A partner can earn several types of income on Schedule K-1, including rental income from a partnership’s real estate holdings and income from bond interest and stock dividends.
Many partnership agreements provide guaranteed payments to general partners who invest the time to operate the business venture and those guaranteed payments are reported on Schedule K-1. The guaranteed payments are put in place to compensate the partner for the large time investment.
A partnership may generate royalty income and capital gains or losses, and those items are allocated to each partner’s Schedule K-1, based on the partnership agreement. Partners should consult with a tax professional to determine if their partnership income impacts the alternative minimum tax calculation.