Schedule K-1 is the form the IRS requires from pass-through entities when reporting an owner’s share of income, deductions, credits, and other tax attributes. Even though partnerships and S-corporations compute and allocate tax items and file them with the IRS, they don’t pay income tax at the entity level. The amounts allocated to each partner or shareholder based on their distributive share must also be reported on their individual tax returns, whether or not the entity actually distributed cash. Each partnership or S-corporation files their K-1 with the IRS and provides a copy to each partner or shareholder.
Since K-1 forms contain sensitive personal information, the entity provides a masked copy to the partner or shareholder wherein the taxpayer identification number is obfuscated. The entity, however, cannot hide or disclose a masked number to the IRS.
Who Receives Schedule K-1
Different pass-through entities and fiduciaries provide different kinds of Schedule K-1s like:
- Partnerships give their partners Schedule K-1 (Form 1065).
- S-Corporations provide their shareholders with Schedule K-1 (Form 1120-S).
- Trust and estate beneficiaries receive Schedule K-1 (Form 1041).
No matter the context, the K-1 is simply an informational return, which is required to be kept, and is necessary to complete Form 1040 or any other relevant documents. Generally, K-1s do not get attached to the return unless there are special instructions like particular codes or additional statements which require that.
Types of Income Reported
A Schedule K-1 breaks down different components of income and assigns them to various rules, limits, and tax assessments. These include:
- income from ordinary business or trade
- income or loss from rental real estate
- other rentals
- portfolio and investment income like
- interest earned
- ordinary and qualified dividends
- short- and long-term capital gains and losses
- self-portfolio gain
- other passive activities
- indeterminate components requiring independent analysis by the partner or shareholder
This is done to ensure each component is processed according to the provisions of the Internal Revenue Code.
Deductions and Credits Allocated to Recipients
K-1s explain what deductions, losses, and credits an entity distributes to an owner, such as:
- Section 179 deductions
- Tax credits for foreign taxes
- Charitable donations
- Depreciation and amortization
- Expenses with certain elections made, such as 59(e), 263A(d), 617
Partners need to find whether these deductions can be taken on an individual tax return. Although partners can take the deductions listed on the K-1, some deductions the taxpayer can take will be less because of these limitations:
- Basis limitation (IRS 705, 722, 733, 742, 704(d))
- At-risk limitation (IRS 465)
- Passive activity limitation (IRS 469)
Despite the K-1 showing a capital account balance, only the partner, not the partnership, is responsible for their own outside basis calculations.
Guaranteed Payments
In the case of partnerships, the Schedule K-1 form shows guaranteed payments which show payments made to the partners for services rendered or payments made to the partners for the use of their capital disregarding the profits of the partnership. Guaranteed payments:
- Are allowed to be deducted by the partnership.
- Are ordinary income to the recipient.
- Typically self-employment tax applies.
Unlike partnerships, S-corporations do not allow for guaranteed payments. Instead, shareholder-employees pay themselves W-2 wages.
Impact on Self-Employment Tax
The self-employment tax implications concerning K-1 incomes relates on the type of entity and the ownership position held:
Partnerships: For general partners, and active LLC members, they regularly include their distributive share of all income in net earnings from self-employment. Guaranteed payments are also included in self-employment income. Limited partners are usually exempt from SE tax on feedback shares, but not on guaranteed payment for services.
S-Corporations: Shares from S-Corporation income are not subject to self-employment tax. However, shareholder-employees are required to pay FICA payroll taxes.
Penalties for Late Delivery of Schedule K-1s
The IRS imposes penalties when entities fail to supply timely, complete, and accurate Schedule K-1s or fail to file the underlying returns when due. Penalties apply both to:
- Failure to furnish K-1s to partners or shareholders
- Failure to include correct information on filed K-1s
Late K-1s can also trigger practical consequences for recipients, such as the need to file an extension or amend an already-filed return.
Additionally, partners may face penalties if they fail to follow the required reporting rules, such as:
- Filing Form 8082 when reporting items inconsistently with the partnership
- Providing notice to the partnership regarding certain transfers under 751(a)
- Fulfilling nominee reporting obligations
Importance of Receiving the K-1 Before Filing Form 1040
It is essential that recipients receive their Schedule K-1 before the individual tax filing deadline, as the K-1 includes critical data required to complete Form 1040. If the K-1 is missing, late, or incorrect:
- The taxpayer often must request an extension of their return.
- Filing without the K-1 may result in errors and require an amended return.
- The IRS may assess penalties if required K-1 information is omitted.
Deadlines for Issuing Schedule K-1s
The deadline for furnishing Schedule K-1s corresponds to the due date of the entity’s return:
- March 15 for:
- Partnerships filing Form 1065
- S-corporations filing Form 1120-S
If the entity obtains a six-month extension, the K-1 distribution deadline is extended to September 15.
If you’re dealing with late, missing, or confusing K-1s, reach out to Dimov Tax for help interpreting your form, checking basis and SE tax exposure, and filing your return accurately and on time.