K-1

Schedule K summarizes the various partnership tax items allocated to each of the partners on their Schedules K-1. Schedule K is the link between Form 1065 and the Schedules K-1. For example, Schedule K includes partnership trade or business ordinary income (from Form 1065, Page 1, Line 22) on Line 1, and a portion of this amount is then reported on Line 1 of each of the partners’ Schedules K-1.

Schedule K and the corresponding lines of the partners’ Schedules K-1 are devoted to information necessary for the partners to make tax computations with respect to both ordinary income (Line 1) and all separately stated partnership items (e.g., rental activity income or loss, capital gains, charitable contributions, investment interest expense, etc.) that may require special handling at the partner 67 level. Additional lines cover tax credits, self-employment income, and alternative minimum tax (AMT) with respect to partnership items.

Schedule K-1 can be confusing because it includes regular tax income, gain, loss, and deduction, and various other amounts needed to compute limitations on deductions, the partner’s AMT, the partner’s basis in his partnership interest, etc. Thus, it can be a challenge for a partner to determine which amounts are “income” and “deductions,” and which amounts are informational items only. By the same token, it is a challenge for the Form 1065 preparer to complete Schedule K-1 in a manner that is easy to understand.

The following tips can help taxpayers and practitioners avoid errors related to Schedule K-1:

1. Report income in the proper location on individual returns as instructed by Schedule K-1 column (c).

2. Avoid netting or combining income and deductions on Schedule E, except for passive activity income and deductions from Form 8582. Generally, income and related deductions (such as un-reimbursed partnership expenses and the Section 179 expense deduction) must be reported separately.

3. Report losses carried forward from prior years due to the at-risk and basis limitations on a separate line of Schedule E. Do not combine them with amounts reported for the current year.

4. Refer to Form 8582, Passive Activity Loss Limitations, for instructions on properly reporting income and losses from passive activities. Beginning in 2002, filers of Form 8582 must attach all three pages of Form 8582 (including the worksheets) to their tax returns.

5. Report flow-through income even if a Schedule K-1 has not been received at the time the Form 1040 is filed. Except for partners in certain small partnerships, Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR), must be attached to the tax return to indicate that the partner, shareholder, or beneficiary either did not receive a Schedule K-1 or disagrees with the amounts on the Schedule K-1.

6. Identify amended information by checking the “Amended K-1” box on the Schedule K-1. The flow-through entity is responsible for ensuring that the box is clearly marked.