What is Schedule K-1?
Schedule K-1 is an Internal Revenue Service (IRS) tax form used for business partnerships to report each partner’s income, deductions, and credit from the partnership for the tax year. The IRS is the United States federal agency responsible for taxes. The IRS’s Canadian equivalent is the Canadian Revenue Agency (CRA), and the Canadian equivalent of Schedule K-1 is the T5013.
- Schedule K-1 is an IRS tax form used by partnerships to report income, deductions, and credit of their partners. The Canadian equivalent of Schedule K-1 is the T5013.
- K-1 splits partnership earnings so that earnings can be taxed at an individual income tax rate instead of the corporate tax rate.
- The three variations of Schedule K-1 forms for different users are Form 1065, Form 1041, and Form 1120-S
How Does Schedule K-1 Work?
Partnerships are categorized as “pass-through entities,” meaning that partners can shift the business’ tax liability to the individual partners themselves. Instead of paying corporate tax on business earnings, such earnings pass through to the partners, who then pay personal income tax on their claim.
Schedule K-1 reports the division of earnings to each partner for taxation purposes and must be completed individually. Division of earnings is decided between the partners themselves and is commonly based on each partner’s contribution or pre-existing partnership agreements. If partners choose to reinvest their earnings back into the business, no earnings will be reported on the K-1.
If the partnership makes a loss over the tax year, partners can indicate the loss on the K-1 and carry the amount forward until a year of profit for a future tax deduction. Consecutive years of net losses can accumulate and be used to apply against future income.
For example, a partnership makes losses of $60,000 each year for the first two years of operations. In the third year, it makes a profit of $150,000. Therefore, the partnership makes no tax payments on the first two years of losses. For the positive year (third year), the partnership is taxed on [$150,000 – ($60,000 x 2)] = $30,000. As mentioned, the earnings amount is then split between the partners and taxed at their individual income tax brackets.
Who Files for Schedule K-1?
The three Schedule K-1 forms for different users are:
1. Form 1065 (Partnerships)
Form 1065 encompasses all types of partnerships, including general partnerships, limited partnerships (LP), and limited liability partnerships (LLP). Certain limited liability corporations (LLC) with multiple members may be taxed as a partnership using the form.
2. Form 1041 (Beneficiaries of Trusts and Estates)
Beneficiaries who inherit income-producing trusts and estates must file through Form 1041.
3. Form 1120-S (S Corporations)
Form 1120-S is reserved for S Corporations – domestic corporations with less than 100 shareholders and only one class of stock. Shareholders of S corporations are taxed as partners.
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