Partnerships don’t pay federal income tax. Instead, the partnership’s income, losses, deductions and credits pass through to the partners themselves, who report these amounts—and pay taxes on them—as part of their personal income tax returns.
Even though partnerships aren’t taxed, they must file a tax return each year unless the partnership has no income or expenses.
The return will show the partnership’s total income, deductions and credits. Partnerships also must prepare schedules showing each partner’s share of the business income or loss. They may also have to file state tax returns and pay certain state taxes.
Whether you operate as a general partnership or a limited partnership, you’ll follow the same basic procedure for filing business taxes. However, limited partners are subject to slightly different tax treatment than general partners.
Here are the five steps you’ll need to follow to file business taxes for your partnership.
1. Prepare Form 1065, U.S. Return of Partnership Income
Every partnership must prepare a federal partnership tax return on Internal Revenue Servicer Form 1065. On this form, you’ll be asked to provide the partnership’s total income or loss.
You will list deductions such as salaries, guaranteed payments to partners, rent, repairs, taxes, depreciation and employee benefit programs. Your partnership’s total income, less its deductions, is its ordinary business income.
You’ll also need to fill out several Form 1065 schedules. Schedule B includes a series of questions about your partnership—from the types of partners to ownership of corporate shares to types of distributions made.
Schedule K is a schedule of income and expenses that forms the basis for the K-1 forms you’ll issue to shareholders. Schedule L is a balance sheet. Some partnerships are also required to complete schedules M-1, M-2 and/or M-3.
The return must be signed by a general partner.
2. Prepare Schedule K-1
Partnerships are also generally required to complete a federal Schedule K-1, Partner’s Share of Income, Deductions, Credits etc., for each person who was a partner at any point during the tax year.
The K-1 form lists the partner’s name, address and percentage share of profits, losses, capital and liabilities. It then lists the partner’s share of ordinary business income or loss, rental income or loss and interest income. It also includes the partner’s self-employment income, credits and distributions.
Once you’ve prepared a Schedule K-1, you must send a copy to each partner no later than March 15th. Partners can then use the K-1 form to prepare their personal tax returns.
3. File Form 1065 and Copies of the K-1 Forms
Partnerships must file copies of the K-1 forms with their Form 1065. The filing deadline for Form 1065 is March 15th.
Most partnerships can file the forms either electronically or by mail.
4. File State Tax Returns
Your state may require partnerships to file a state tax return. Depending on the state, partnerships may be required to pay franchise, excise or sales taxes. You can find the tax filing requirements for your state online at its department of revenue website.
5. File Personal Tax Returns
If you are a general or limited partner, you must report your share of the partnership income or loss on your federal income tax return. The Schedule K-1 you receive from the partnership contains the information you need to do this.
In addition, if you are a general partner, your partnership income will typically be considered self-employment income. You will report this on your personal tax forms and calculate self-employment tax using Form SE.
Because limited partners typically aren’t involved in running the business, their income is considered passive income. If the partnership operates at a loss, they can only use that loss to offset other passive income.
In addition, limited partners’ income is not considered self-employment income except to the extent that they receive guaranteed payments for services they actually perform for the business partnership.
Filing partnership taxes is a multi-step process, and you may want to consult an accountant or invest in tax preparation software to help you complete your returns. To avoid late filing penalties, be sure to comply with federal and state filing deadlines.