If you’re a business owner, it seems as though the mountain of tax forms might never end.
Today, we’re talking about one that isn’t as well-known, but is critical to individual corporate professionals: Schedule K1.
Applying to certain types of entities that utilize pass-through taxation, this is a critical tax form that can be difficult to understand if you’re filing it for the first time.
Join us today as we take a closer look at what IRS Schedule K1 includes and how to complete it.
What is Pass-Through Taxation?
A corporation that qualifies as a pass-through business is exempt from paying the IRS-mandated corporate income tax. Instead, the company’s income is reported on each owner’s individual income tax return.
In most cases, these corporations include the following business types:
- Sole proprietorships
- Partnerships (such as LLCs)
- S Corporations
In addition to paying individual income tax, pass-through businesses also pay self-employment taxes, as well as state and local taxes.
What is Schedule K1?
At its core, the pass-through taxation setup shifts the tax liability away from the corporation. It then puts the tax onto the shoulders of those who have an interest in it.
Still, that doesn’t mean the corporation can take advantage of this opportunity to lower its reported earnings.
The K1 Schedule is designed to ensure that.
This form serves as a place for business owners to report profit amounts “passed through” the business to each individual.
If you’re a sole proprietor, you’ll report your income on Schedule C of IRS Tax Form 1040. However, business partnerships and S corporations will use Schedule K1.
Let’s take a look at the steps to consider when you’re ready to file.
Schedule K1 Instructions: Business Partnerships
Does your business operate as a partnership? If so, the partners will pay taxes on your business income, not the company itself.
That means that each partner will be responsible for completing his own individual tax return that reports his specific share of:
- Business income
- Business losses
- Business credits
- Business deductions
Note that this information should be in keeping with the numbers that the partnership reported on IRS Form 1065: U.S. Return of Partnership Income. You can find Schedule K1 under the “Income and Expenses” section of this form.
In addition to ordinary business income or losses, you’ll also need to report any other financial gains that you received through the partnership. This includes:
- Real estate income
- Interest income
- Guaranteed payments
- Foreign or overseas transactions
- Capital gains
Using Schedule K1 to Determine Financial Basis
While the partners will take care of their own individual returns, the partnership itself must complete and submit a Schedule K1 with its tax return. Also, each partner should receive a copy of the completed Schedule K1 so they can report that same information on their individual return.
For example, if a partnership earns $200,000 of taxable income and has five equal partners, each partner should receive a Schedule K1 with $40,000 of income on it.
One of the purposes of a Schedule K1 is to require partnerships to actively track each partner’s financial participation (called “basis”) in the overall enterprise.
The form reveals how the partnership’s total returns are distributed to each partner and, thus, how that relates to that partner’s capital.
In other words, the Schedule reveals the size of your piece of the pie in the partnership. It also helps you determine how much of the partnership’s capital or losses you have to report on your personal tax return.
Schedule K1 Instructions: S Corporations
As partnerships still have to file Form 1065, S Corporations also have their own separate form to complete in addition to Schedule K1. This is known as IRS Form 1120S.
While a partnership has invested partners, S Corporations have shareholders. In fact, for a company to be designated as an S Corporation, it has to have fewer than 100 stockholders and be taxed as a partnership.