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The advantages of forming a partnership are manifold and range from harnessing the knowledge of your partners to favorable taxation.
Still, you should be familiar with IRS Form 1065 and partnership tax returns before registering your business as a partnership.
The five-page tax document declares a partnership’s profits, losses, and deductions. But you’ll need many IRS forms and financial documents to complete it.
Form 1065 doesn’t show the partnership’s tax liability because its purpose is only to report a company’s total net income.
Businesses must use Schedule K-1 to calculate each partner’s tax liability and attach these documents to their partnership tax return.
This guide will take you through the steps your company must take to prepare a partnership tax return and file IRS Form 1065.
Table of Contents
Understanding the Purpose of IRS Form 1065
The IRS defines a partnership as a ‘relationship between two or more people to do trade or business, and each person contributes money, labor or skill, and shares in the profits and losses of the business.’
Moreover, businesses owned and managed by spouses who share the profits and losses are recognized as partnerships for tax purposes, so they must complete partnership tax returns.
Like S corporations, partnerships are pass-through entities, meaning all their income and losses pass through to the partners. Moreover, the IRS treats all LLCs with two or more members as partnerships and requires them to report their taxes on Form 1065.
The form is an information return that collects the partnership’s credits, deductions, gains, income, losses, and other financial information.
Besides the form, a partnership must attach Schedule K-1 (Form 1065), which reports the share of the profits distributed to each partner.
How to Know if Your Partnership Must File IRS Form 1065?
Domestic partnerships, including LLCs, general partnerships, and limited partnerships, must file IRS Form 1065 at the end of the tax year during which they generate profit.
Filing this form doesn’t mean the partnership is responsible for paying federal taxes. On the contrary, each partner or member must report and pay taxes for their share of the business on their tax return.
Aside from partnerships headquartered in the United States, foreign partnerships also must report their financial information on Form 1065.
Companies that generate income from US sources, conduct business, or trade in the United States must use Form 1065 to report their worldwide income and demonstrate how it is distributed among partners.
501(d) nonprofit religious and apostolic organizations must also file Form 1065 annually.
Filing Exemptions
A foreign partnership should complete Form 1065 even if all its partners are foreign nationals or its principal place of business is outside of the US.
However, there are exceptions to this rule, but the criteria a business with and without US partners must meet to qualify for the filing exemption are slightly different.
- Partnerships with US partners: Filing Form 1065 isn’t necessary if a business generates under $20,000 from US sources or doesn’t earn any income from business or trade in the US. Partnerships that allocate less than 1% of credit, loss, deduction, gain, or income to direct US partners don’t have to file this form. Withholding foreign partnerships don’t have to complete this form.
- Partnerships without US partners: A foreign partnership with no US partners is exempt from filing Form 1065 if each partner satisfies their tax liability under Sections 1.1641-1(b) or (c) and files Form 1042 or Form 1042-S. The exemption isn’t available if a business generates income effectively connected to a US source or has one or more US partners.
Completing IRS Form 1065
Keeping a detailed record of the partnership’s finances is paramount for completing Form 1065 correctly.
The information you must provide on a partnership tax return is unique to your business, so you must study each section carefully and read the instructions booklet to understand what is required of you.
Remember that the instructions booklet for Form 1056 is a 65-page document that addresses all aspects of preparing a partnership tax return. You should study this document to keep up with the latest regulations and avoid making mistakes.
Collecting the Necessary Tax Documents
The first stage of preparing a partnership tax return involves gathering the financial and tax documents you need to complete Form 1065. Most importantly, you must have access to the partnership’s profit and loss statements and balance sheet.
Other documents you might need to fill out Form 1065 include:
- Form(s) W2 or W3
- The total value of sold goods
- Receipts
- Form 1042, 1042-S or 1042-T
- Form 1099
- Form 4562
- Form 114
- Form 3520
Please note that this list only includes some forms and tax documents partnerships may need to complete Form 1065. The information you must provide on a partnership tax return depends on the partnership’s activities.
It’s also worth pointing out that partnerships must issue Form 1099 to each independent contractor they hire during a tax year if the value of the service exceeds $600.
General Information About a Partnership
The first page of Form 1065 collects information about a partnership, its income, deductions, and tax payments.
The return preparer should enter the business’ EIN, principal activity, product or service, total assets, code number, name, and address, at the top of the form.
The remainder of the form’s first page gathers information about the partnership’s payments, deductions, and taxes. You’ll need information from various tax forms, including Form 1125-A and Form 4797, to calculate the partnership’s total income.
The Deductions subsection should include the amount spent on rent, guaranteed payments to partners, wages, retirement plans, and similar information. The Tax and Payment subsection lets you determine the overpayment and due amounts.
A partner or an authorized return preparer should sign the form’s first page and indicate if the IRS can contact them to discuss the return.
Filling out the Schedules
The remaining four pages of Form 1065 feature Schedules B, K, L, M-1, and M-2.
The purpose of Schedule B is to collect technical information about a partnership, including its type, ownership percentages, debts, etc. The schedule contains a series of yes or no questions, and you’ll need various financial documents to answer each question.
Schedule K declares all partners’ distributive share items, such as guaranteed payments or royalties. Schedule L lists all company’s assets, capital, and liabilities at the start and end of the year.
Partnerships that meet all Question 4 requirements don’t have to complete Schedule L. Schedule M-1 reconciles the partnership’s loss per its books with its income loss on the tax return.
Schedule M-2 analyzes each partner’s capital account, including cash or property. Some of the items in this schedule must match the information from Schedules L and M-1, so you must double-check if the numbers in each schedule are accurate.
Schedule K-1 (Form 1065)
A business partnership must prepare Schedule K1 (Form 1065) to calculate its tax liability for each partner. Partners must use this tax document to establish the tax liability they must report on their tax returns.
Aside from the information about the partnership and the partner, Schedule K1 should include a detailed account of income, dividends, and royalties a partner receives from a partnership during the year.
The partnership must attach copies of Schedule K1 for each partner to Form 1065, while partners only use the information from this document to report their income and pay taxes.
Meeting the Filing Deadline
A partnership must file Form 1065 with all necessary Schedule K-1s within three and a half months after the end of the tax year.
Hence, the partnership tax return is due by March 15 unless the date falls on a weekend or a holiday, in which case the filing deadline is the next working day.
All partnerships are eligible for an automatic six-month filing extension if they cannot prepare their tax return by mid-March. A partnership must file Form 7004 to extend the filing deadline until September 15.
Frequently Asked Questions
Most tax preparation software supports Form 1065 and allows you to submit it in an electronic form to the IRS. Partnerships with more than a hundred partners must e-file the form.
Partnerships are only required to report their income on Form 1065. But they don’t pay taxes because their profit is distributed to partners who must report their share of the revenue from a partnership and pay taxes.
The IRS assesses a $220 late filing penalty per partner for each month or part of the month Form 1065 is delayed.
Spouses who own and run a partnership can avoid filing Form 1065 by electing to be treated as Qualified Joint Venture on their joint tax return.
Reporting Partnership’s Income on IRS Form 1065
Preparing a partnership tax return is a mandatory step your business must complete each year.
IRS Form 1065 is one of many documents a partnership must submit to the IRS because the company is responsible for issuing Schedule K-1 (Form 1065) to each partner and sending copies to the IRS.
Moreover, you’ll need a broad range of IRS tax forms and financial documents to complete Form 1065 and establish the company’s total income and tax liability.
This process can be tedious, so most partnerships hire paid preparers to ensure their partnership tax returns are completed correctly and filed on time.
Author:
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.
