Understanding Schedule K-1: A Guide to Tax Form 1065

At a glance:

• The main takeaway: Schedule K-1s may seem daunting, but with a little guidance you can understand and use this important tax document to prepare your tax return.
• Impact on your business: To avoid costly penalties, it’s important to review each line item and make sure there are no errors when you file your Schedule K-1. 
• Next steps: Aprio’s Tax advisors can help you navigate your Schedule K-1, so you are accurately reporting your income and maximizing your deductions and credits. 

Schedule a consultation

Full story

If you’ve received a Schedule K-1 (Form 1065, 1120-S, or 1041), you might be wondering what it means and how it impacts your taxes. This guide will help you understand the basics of Schedule K-1 and how to read it effectively.

What is a Schedule K-1?

A Schedule K-1 is an important tax document that is used to report your share of income, deductions, credits, and other financial details that are passed through to partners, shareholders, S corporations, or beneficiaries from certain entities. These entities don’t pay taxes at the entity level. Instead, they pass the responsibility of reporting and paying taxes to the individuals who have an ownership interest or are beneficiaries. There are three main types of entities that issue a Schedule K-1:

1. Partnerships (Form 1065): Partnerships file an informational return with the IRS and issue Schedule K-1s to each partner, detailing their share of the partnership’s income, deductions, and credits.
2. S Corporations (Form 1120-S): S corporations pass income and other tax attributes to shareholders, who report these amounts on their individual tax returns.
3. Trusts and Estates (Form 1041): Trusts and estates issue Schedule K-1s to beneficiaries, outlining distributions of income and deductions allocated to them.

How to read your Schedule K-1

Each Schedule K-1 is tailored to the type of entity that issues it, but they all include critical sections and information that taxpayers must understand. Below is a breakdown of the key components:

1. Basic Information

• Part I: Information about the entity
  • This section identifies the entity issuing the Schedule K-1, including its name, address, and Employer Identification Number (EIN). It’s important to verify this information to ensure the form corresponds to the correct entity.
• Part II: Information about the recipient
  • This section contains your details, including your name, address, and taxpayer identification number. Check this information for accuracy to avoid discrepancies when filing your tax return.

2. Income Items

• Partnership or S corporation income (Schedule K-1 from Form 1065 or 1120-S):
  • Box 1: Ordinary business income or loss—This is the entity’s net income or loss from its operations.
  • Box 2: Net rental real estate income or loss—If the entity has rental properties, this reflects your share of the results.
  • Box 3: Other net rental income or loss—Covers non-real estate rental activities.
• Trust or estate income (Schedule K-1 from Form 1041):
  • Box 1: Interest income—Taxable interest earned by the trust or estate.
  • Box 2a: Total ordinary dividends—Dividends distributed to you.
  • Box 3: Net short-term capital gains—Gains from investments held for one year or less.

3. Deductions and Credits

• Deduction items, such as depreciation or guaranteed payments, are reported separately to allow you to determine their specific treatment on your tax return. These items might be found in boxes such as:
  • Box 12: Section 179 expense deductions
  • Box 13: Other deductions (e.g., charitable contributions or health insurance deductions for partners)
• Credits include tax benefits you may claim directly on your return, such as:
  • Box 15: Credits (e.g., low-income housing credits or foreign tax credits)

4. Self-Employment Items

• Certain income or deductions may affect your self-employment tax. Look for:
  • Box 14: Self-employment earnings (or loss)

5. Supplemental Information

• At the end of the Schedule K-1, there is often a section for supplemental information, which provides additional details or instructions for specific line items. For example, you might see information about the allocation of qualified business income (QBI) for purposes of the Section 199A deduction.

How to use a Schedule K-1 when filing your tax return

Once you’ve reviewed your Schedule K-1, the next step is to report the information on your tax return. Here are some tips to help you:

1. Match Each Line Item to Your Tax Return:
   • For partnerships and S corporations, most income and deduction items will flow to Schedule E (Supplemental Income and Loss) of your Form 1040.
   • For trusts and estates, income items often appear on Schedule E as well, but some may flow to other schedules based on their nature (e.g., capital gains on Schedule D).
2. Apply Passive Activity Rules:
   • If you are not actively involved in the operations of the partnership or S corporation, certain income and losses may be classified as passive. Passive activity losses are subject to limitations, which means they may not be deductible in the current year.
3. Calculate Self-Employment Tax:
   • Income reported in Box 14 may be subject to self-employment tax. Use Schedule SE (Self-Employment Tax) to calculate and report this.
4. Don’t Double Count:
   • Some items, such as qualified dividends or capital gains, are already taxed at preferential rates and should be reported in the appropriate sections of your return.
5. Watch for Adjustments:
   • The entity issuing the Schedule K-1 may include items requiring adjustments, such as tax-exempt income or distributions that exceed your basis in the entity. These details are often found in the supplemental information section.

Common questions about Schedule K-1

What if My Schedule K-1 Shows a Loss?

If your Schedule K-1 reports a loss, you might be able to deduct it on your tax return. However, limitations apply, including:

• Basis Limitation: You can only deduct losses up to your investment basis in the entity.
• At-Risk Rules: Losses are limited to the amount you have at risk in the business.
• Passive Activity Rules: Losses from passive activities can only offset income from other passive activities.

What Happens if My Schedule K-1 is Late?

Many partnerships and S corporations file their tax returns close to the extended deadline, so you may receive your Schedule K-1 later in the tax season. If you’re still waiting on your Schedule K-1 near the filing deadline, consider filing for an extension using Form 4868.

What if I Find an Error?

If you discover an error on your Schedule K-1, contact the entity immediately to request a corrected form. Do not file your tax return with incorrect information, as it can lead to complications with the IRS.

The bottom line

Schedule K-1s may seem daunting at first, but with a little guidance, you can understand and use it to prepare your tax return. Take the time to review each line item, and don’t hesitate to seek assistance if needed. Remember, the IRS relies on the information from your Schedule K-1, so accuracy is key. Aprio’s Tax advisors can help to ensure you’re accurately reporting your income and maximizing your deductions and credits.