Schedule K-1 Federal Tax Form: What Is It and Who Is It For?

What Is Schedule K-1?

Schedule K-1 is a federal tax document used to report the income, losses, and dividends for a business' or financial entity's partners or an S corporation's shareholders. The K-1 form is also used to report income distributions from trusts and estates to beneficiaries.

A Schedule K-1 document is prepared for each relevant individual (partner, shareholder, or beneficiary). A partnership then files Form 1065, the partnership tax return that contains the activity on each partner's K-1. An S corporation reports activity on Form 1120-S. Trusts and estates report the K-1 form activity on Form 1041.

Understanding Schedule K-1

The U.S. federal tax code allows the use of a pass-through strategy in certain instances, which shifts tax liability from the entity (such as a trust or a partnership) to the individuals who have an interest in it.

The entity itself pays no taxes on earnings or income. Rather, any payouts—along with any tax due on them—pass through directly to the stakeholders. This is where Schedule K-1 comes in.

The purpose of the K-1 form is to report each participant's share of the business entity's gains, losses, deductions, credits, and other distributions (whether or not they're actually distributed).

In the case of a partnership, while not filed with an individual partner’s tax return, the financial information posted to each partner’s K-1 form is sent to the IRS with Form 1065. Income generated from partnerships is added to the partner’s other sources of income and entered on Form 1040.

Aspects of Schedule K-1

Factoring in Partnership Agreements

A partnership is defined as a contract between two or more people who decide to work together as partners. The rules of this business arrangement are stated in a partnership agreement. The partnership has at least one general partner (GP) who operates the partnership.

GPs are liable for their actions as partners and for the activities of other GPs in the partnership. Limited partners, on the other hand, are liable for the debts and obligations of the partnership based only on the amount of capital they contribute. The partnership agreement dictates how the partners share profits, which impacts the information on Schedule K-1.

Basis Calculation

Schedule K-1 requires the partnership to track each partner’s basis in the partnership. In this context, basis refers to a partner’s investment or ownership stake in the enterprise. A partner’s basis is increased by capital contributions and their share of income. It's reduced by a partner’s share of losses and any withdrawals.

Assume, for example, that a partner contributes $50,000 in cash and $30,000 in equipment to a partnership, and the partner’s share of income is $10,000 for the year. That partner's total basis is $90,000, less any withdrawals they've made.

The basis calculation is important because when the basis balance is zero, any additional payments to the partner are taxed as ordinary income. The basis calculation is reported on Schedule K-1 in the partner’s capital account analysis section.

Income Reporting

A partner can earn several types of income on Schedule K-1, including rental income from a partnership’s real estate holdings and income from bond interest and stock dividends.

Many partnership agreements provide guaranteed payments to general partners who invest the time to operate the business venture and those guaranteed payments are reported on Schedule K-1. The guaranteed payments are put in place to compensate the partner for the large time investment.

A partnership may generate royalty income and capital gains or losses, and those items are allocated to each partner’s Schedule K-1, based on the partnership agreement.

Types of Schedule K-1s

The K-1 forms used by the three entities, partnerships, S-corporations, and trusts vary slightly in the way they look but they all have the same purpose. They report to the IRS, and individual partners, shareholders, and beneficiaries, the amounts of income, losses, deductions, credits and other distributions they may have received.

K-1 Form for Partnerships

K-1s are provided to the IRS with the partnership’s tax return (Form 1065) and also to each partner so that they can add the information to their own tax returns.

K-1 Form for S-Corporations

S-corporations file an annual tax return using Form 1120-S. They include Schedule K-1 information about each shareholder’s share of income, losses, deductions and credits.

K-1 Form for Trusts and Estates

Trusts and estates use Form 1041 to file their tax returns. Beneficiaries receive a K-1 that shows the income that they need to report on their own tax returns.

Who Files a Schedule K-1?

Usually, no individual taxpayer typically has to file it but you or your tax preparer will transfer the information on it to an individual tax return. For example:

If you're a partner, use the information on Schedule K-1 to prepare your income tax return(s). You typically aren't required to attach the K-1 form (unless specifically required per the form instructions) but be sure to keep it in your records. The partnership files a copy of Schedule K-1/Form 1065, the U.S. Return of Partnership Income, with the IRS.

If you're a shareholder, use the information on Schedule K-1 (Form 1120-S) to prepare your income tax return(s). Again, you usually aren't meant to include the K-1 form with them but file it with with your records. The corporation files Form 1120-S, the U.S. Income Tax Return for an S Corporation, with the IRS.

If you're a beneficiary of a trust or estate, use the information on Schedule K-1 (Form 1041) to prepare your income tax return(s). The K-1 isn't filed with your tax return, unless backup withholding was reported in box 13, code B. Keep it with your records. The trust or estate files a copy of Schedule K-1/Form 1041 with the IRS.