Real Estate Investing
What is a Schedule K-1 Tax Form and How Do They Work?
The Schedule K-1 is a tax form through the Internal Revenue Service (IRS) that is used by business partners to report their share of the profits, losses, credits, and deductions to the IRS. The Schedule K-1 tax form requires businesses to keep track of everyone's individual stake in the business.
According to Investopedia, the reason for the Schedule K-1 is for a business to use 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." The Schedule K-1 is how these pass-through entities can keep track of the earnings and income of the stakeholders, which are then reported to the IRS on that form. The Schedule K-1 essentially shows the IRS how much of the partnership of the pass-through entity belongs to each person involved and determines the tax liability for each individual.
In this article, we will share everything you need to know about the Schedule K-1.
Who must file Schedule K-1?
There are a few business entities that may need to file a Schedule K-1. The form and the rules are slightly different for each one, so we will break down the differences for each business entity that needs to file a Schedule K-1.
Schedule K-1 for Partnerships
For a partnership, the partners are responsible for paying the taxes for the income of the business instead of the business itself. Every partner is responsible for filling out their own individual tax return that reports their share of the income, losses, deductions, and tax credits that the business reports on their 1065 tax form. Each partner needs to prepare their Schedule K-1 form with their shares.
For example, if a business with four partners earned $200,000 in taxable income, then each partner would need to submit a K-1 form with $50,000 of income listed on it.
S Corporations and Schedule K-1's
An S corporation has similar rules to the partnership when it comes to the Schedule K-1 form. The S corporation has to file a tax form 1120S for its annual return. Each shareholder in the S corporation will have a Schedule K-1 that reports their shares of the income, losses, and any tax credits or deductions. Each shareholder will use their K-1 to report that information on their tax returns.
Trust and Estate Beneficiaries
The Schedule K-1 works differently for a trust or estate. The trust or estate will fill out a tax form 1041 for their tax return. Sometimes the trust will pay the income take on their earnings instead of having the beneficiaries pay the taxes themselves, which complicates the matter a little bit. If the trust or estate does pass the income to the beneficiaries, they will receive a K-q with their income to report on their tax return.
Exchange-Traded Funds and Schedule K-1
Exchange-traded funds that invest in currencies and commodity futures are frequently set up as a limited partnership. An investor in an exchange-traded fund might receive a Schedule K-1 form to report their income from the fund instead of a 1099. The Schedule K-1 is similar to a 1099 form, so if you are used to 1099s, you should be able to navigate through the Schedule K-1 form without trouble. You can find out if your exchange-traded fund is set up as a limited partnership by looking at the prospectus of the fund or by consulting with your accountant.
How does a K-1 affect my personal taxes?
If your business qualifies as a pass-through entity, you can deduct up to 20 percent of your net business income from your personal income taxes. The Schedule K-1 essentially helps you reduce your personal tax liability.
For example, if you own a business with a partnership and your Schedule K-1 says that your income for the year was $50,000, you can reduce your taxable income by 20 percent, making it $40,000 instead. This means that amount of income tax you owe for the year goes down, which can be beneficial.
Is Schedule K-1 considered income?
That depends on your participation and status in the entity. If you are a partner and active business owner, the income on your K-1 can be considered income. If you are a limited partner, passive investor, or trust or estate beneficiary, the money on your Schedule K-1 is more like unearned income. When you file your taxes, you must make sure that you attach your Schedule K-1 form with the other documents. The IRS will not accept your tax return if you do not include your Schedule K-1.
When Are Schedule K-1s Due?
The Schedule K-1 is due by March 15, according to the IRS, but it seems to be open to interpretation whether they need to be issued by then or if it needs to be in the hands of the taxpayer by then. The Schedule K-1 is notorious for arriving late because of the ambiguity in when they are due. We recommend aiming to have them in the hands of your partners by March 15, so they are not stuck waiting on that to fill out their tax returns, especially since tax returns are due only one month later.
Where can I find a sample K-1 tax form?
There is a sample of the Schedule K-1 tax form on the IRS website. You should receive a copy of the Schedule K-1 from whoever is responsible for filing the 1065 for your partnership or trust.
What’s the Difference Between Schedule K-1 Form 1065 and Form 1120S?
A partnership files its Schedule K-1 on the Form 1065, while an S corporation files theirs on the Form 1120S.
While the Schedule K-1 is a little different depending on where it comes from, they all have detailed information on your income, losses, and deductions for the year so that you can file your taxes accurately. It is also crucial to understand the impact of your involvement in the business and how this affects your tax liability for Schedule K-1 and personal income.
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