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At Padgett, we are proud to provide tax and accounting services to empower America’s small businesses. Partnership taxation can be complicated. Our team of small business tax advisors is here to make sure you get it right. In this article, you will find a breakdown of the key things to know about Form 1065 and partnership tax returns more generally.
Taxation for partnerships involves a unique set of rules that every partner should understand to ensure proper tax planning and compliance. Partnerships do not pay federal income tax at the entity level. Instead, the partnership’s income, deductions, and credits flow through to the individual partners, who report their share of these items on their individual tax returns. In other words, partnerships are pass-through entities.
Beyond reporting their share of partnership income on their individual tax returns, partners are generally also responsible for paying self-employment taxes (Social Security and Medicare) on all income that passes through to them from the partnership (unless they’re limited partners). It is imperative that partnerships maintain accurate financial records and track expenses throughout the year. By understanding the basics of partnership taxation and staying organized, partners can better navigate the tax filing process and optimize their tax situation.
The Bottom Line: A partnership is a pass-through entity. That being said, the partnership still must file IRS Form 1065. The information on this form is used to generate a Schedule K-1 for each individual partner. Schedule K-1 ensures that income and expenses are properly reported on each partner’s individual tax return.
Form 1065 is the federal tax form that partnerships use to report their income and expenses. Even though a partnership is a pass-through entity for the purposes of federal taxation, it is still crucial that Form 1065 be accurate. The information provided on the form is used to allocate income and expenses to individual partners. Form 1065 consists of several parts and schedules that require detailed information about the partnership’s financial activities. Here are some of the most important:
Income: Within this section of Form 1065, the partnership reports its gross receipts, and other trade or business income. The cost of goods sold is subtracted here, and certain net gains and other income are also reported to determine total income (or loss).
Deductions: This is where the partnership lists its tax-deductible expenses. Some examples are salaries, guaranteed payments to partners, rent, taxes, interest, and depreciation. These deductions are subtracted from total income (loss) to calculate the partnership’s ordinary business income (or loss). This amount will then be used in determining each partner’s distributive share.
Schedule B, Other Information: Various other information related to the partnership’s operations and tax matters are reported here. Depending on the nature of the partnership, Schedule B may be extremely important, or it may be largely inapplicable.
Schedule K, Partners’ Distributive Share Items: The partnership must allocate its income, losses, deductions, and credits to each partner based on their respective shares. You need to work with an experienced small business tax professional to ensure that Schedule K is completed properly. Remember, the partners will use this information to complete their individual tax returns.
Schedule L, Balance Sheet: This requires the partnership to provide a balance sheet showing its assets, liabilities, and partners’ capital accounts. Details should be provided for both the start and end of the tax year.
After the partnership completes Form 1065, each partner should receive a Schedule K-1 from the partnership. Using the information on this tax form, each partner can report their share of the partnership’s income, deductions, and credits. Partners must include the information from Schedule K-1 on their individual tax returns. The Schedule K-1 helps ensure that each partner’s share of the partnership income is taxed appropriately.
If a partnership fails to file a complete Form 1065, the IRS may impose penalties on the partnership. The late filing penalty is $220 per partner per month, capped at 12 months. Partnerships can also face penalties for failing to furnish Schedule K-1 to partners on time or without complete and correct information.
At Padgett, our small business tax advisors have the professional skills and financial expertise to help partnerships handle the full range of tax issues. If you have any specific questions or concerns about Form 1065, professional guidance is just a phone call away. Contact us now for a confidential consultation. We provide small tax services to partnerships nationwide.
