What Is Schedule K-1?
Schedule K-1 is a federal tax document used to report the income, losses, and dividends of a business' or financial entity'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.
- Business partners, S corporation shareholders, and investors in limited partnerships and certain ETFs use Schedule K-1 to report their earnings, losses, and dividends.
- Schedule K-1s are usually issued by pass-through business or financial entities, which don't directly pay corporate tax on their income, but shift the tax liability (along with most of their income) to their stakeholders.
- Schedule K-1 requires the business entity to track each participant’s basis or ownership stake in the enterprise.
- Several different types of income can be reported on Schedule K-1.
- Schedule K-1s should be issued to taxpayers no later than Mar. 15 or the third month after the end of the entity's fiscal year.
Understanding Schedule K-1
The U.S. federal tax code allows the use of a pass-through strategy in certain instances, which shifts tax liability from the entity (a trust, a partnership) to the individuals who have an interest in it. The entity itself pays no taxes on earnings or income; rather, any payouts—along with any tax due on them—"pass-through" directly to the stakeholders. This is where Schedule K-1 comes in.
The purpose of Schedule K-1 is to report each participant's share of the business entity's gains, losses, deductions, credits, and other distributions (whether or not they're actually distributed). 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 generated from partnerships is added to the partner’s other sources of income and entered on Form 1040.
Schedule K-1 is similar to Form 1099, in that it reports dividends, interest, and other annual returns from an investment. Whether you receive a K-1 or a Form 1099 depends on the investment. Master limited partnerships (MLPs), real estate limited partnerships (RELPs) and certain exchange-traded funds (ETFs) are all types of investments that routinely issue K-1s.
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.
Schedule K-1 requires the partnership to track each partner’s basis in the partnership. Basis, in this context, refers to a partner’s investment or ownership stake, in the enterprise. A partner’s basis is increased by capital contributions and their share of income; it's 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. That partner's total basis is $90,000, less any withdrawals they've made.
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.
Those receiving K-1-reported income should consult with a tax professional to determine if their proceeds trigger the alternative minimum tax.
IRS Schedule K-1 FAQs
What Is IRS Schedule K-1?
Schedule K-1 is an Internal Revenue Service (IRS) tax form that's issued annually. It reports the gains, losses, interest, dividends, earnings, and other distributions from certain investments or business entities for the previous tax year. These are usually pass-through entities that don't pay corporate tax themselves, because they directly pass profits on to their stakeholders or investors. Participants in these investments or enterprises use the figures on the K-1 to compute their income, and the tax due on it.
Who Gets an IRS Schedule K-1?
Among those likely to receive a Schedule K-1 are:
- S corporation shareholders
- Partners in limited liability corporations (LLCs), limited liability partnerships (LLPs), or other business partnerships
- Investors in limited partnerships (LPs) or master limited partnerships (MLPs)
- Investors in certain exchange-traded funds (ETFs)
- Trust or estate beneficiaries
Is IRS Schedule K-1 Income Considered Earned Income?
It varies, depending on the individual's participation and status. For trust and estate beneficiaries, limited partners, and passive investors, Schedule K-1 income is more akin to unearned income. For general partners and active owners in a business or pass-through business entity, the income can be considered earned income, and they may owe self-employment tax on it.
When Should I Receive My IRS Schedule K-1?
Schedule K-1 forms are notorious for arriving late. The IRS says they are due by March 15 (or the 15th day of the third month after the entity's tax year ends), but whether that means they need just to be issued by then, or to actually be in taxpayers' hands by then, seems open to interpretation. Most authorities agree you should receive one by March 15, or the closest business day to that, though.
Do You Have to File an IRS Schedule K-1?
Yes, you do, if you are a general partner in a limited partnership or owner of a pass-through business entity or S corporation. The K-1 must be filed with your tax return.
For limited partners and trust or estate beneficiaries, actually filling the K-1 along with Form 1040 is usually not necessary (though the data on it must be reported on the return and figured into the calculation of taxable income and income tax owed).