Schedule K-1

          Partnerships, S corporations, trusts, and estates do not usually pay income taxes.  Normally, these entities are required to file information returns, and the income or loss is passed through to the partners, shareholders, or beneficiaries to be reported on their individual tax returns.  An important by-product of these information returns is Schedule K-1.  Schedule K-1 clearly states all the information the partner, shareholder, or beneficiary needs to report their share of the income or loss of the entity.

         The entity files all of the related Schedules K-1 with the Internal Revenue Service, and gives a copy of the K-1 to the related individual.  The individual does not attach the Schedule K-1 to their income tax return.  They keep it for their records.  The Internal Revenue Service matches up the reported Schedules K-1 with all the individual income tax returns to determine that all income gets reported and taxed.

      The information return filed by a partnership is called Form 1065.  This return reports to the Internal Revenue Service the partnership profit or loss, as well as each partner’s share on the K-1.  The partnership must give each partner a copy of their Schedule K-1, listing their portion of income, loss, deduction and credit items, and indicating where to show them on the partner’s income tax return.  General partners are liable for self-employment tax on their share of net partnership income.

         An S Corporation files an information return called the Form 1120-S, showing the profit or loss of the S corporation, and Schedules K-1 for each shareholder, showing their share of income or loss, deductions and credits.  There are several items that get allocated to and passed through to the shareholders based on the amount of stock held in the corporation.  These items include gains and losses from the sale and exchange of capital assets and Section 1231 property, tax-exempt interest, Section 179 deduction, charitable contributions made by the corporation, tax preference items, foreign income or loss, foreign taxes paid by the corporation, and recovery of bad debts and prior taxes.

       Trusts and estates file Form 1041.  A Schedule K-1 is given to each beneficiary showing their share of trust or estate income or loss.  Trust or estate income is treated on your individual income tax return as if the income was received directly from the source rather than from the estate or trust.  Your share of trust or estate income would be reported on your Schedule B for interest and dividends, and on Schedule D for any capital gains.  Schedule E would be used to report your share of income or loss from real estate or business activities as reported on your Schedule K-1 received from the trustee.  This income or loss would be subject to passive activity restrictions as usual.

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