How to Understand K-1 Taxes

If you are a partner, LLC member or S corporation shareholder, you may receive a Schedule K-1 to include with your taxes.
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Schedule K-1 is used as an appendix to several different types of business tax returns to report the proportionate share of the profits or losses of a corporation, partnership (domestic or foreign) or limited liability company (LLC) that is allocated to shareholders, partnerships, or members, respectively. The business is responsible for filing this form with the Internal Revenue Service (IRS) and distributing it to shareholders, partners or members so that they can report it on their individual income tax returns.

Step 1

Determine which version of Schedule K-1 you wish to use. K-1 forms for Form 1120S (S corporation tax return), Form 1065 (partnership tax return) and Form 8865 (foreign partnership return) differ significantly. An LLC with more than one member will be taxed as a domestic partnership using Form 1065 unless it elects to be taxed as a corporation. LLCs electing to be taxed as S corporations must file Form 1120S with Schedule K-1.

Step 2

Calculate the business's total income. Subtract deductible expenses such as payroll and advertising expenses to arrive at net profits or losses. Different types of net profits or losses will have to be broken down into various income components - business income, interest income, rental income, etc.

Step 3

Do not rely on pre-existing company financial statements, because profits or losses might be different when calculated for tax purposes than they are when calculated for company financial statements.

Step 4

Determine the ownership share and profit or loss allocation percentage of each shareholder, partner or member. Remember that the allocation of profits or losses to LLC members need not be equal to ownership shares if the LLC operating agreement provides otherwise. This means that you will have to check the LLC operating agreement (if any) to confirm the allocation of profits or losses.

Step 5

Multiply the business's total profit or loss by the fractional allocation attributable to each shareholder, partner or member, in order to determine the individual allocation of of profits or losses. Record the result on Schedule K-1.

Step 6

Append Schedule K-1 to your company's tax return, file it with the IRS, and send a copy of Schedule K-1 to each shareholder, partner or member.

Tip

Individual taxpayers to whom K-1 profits or losses are allocated do not have to include Schedule K-1 with their individual income tax returns.

Warning

Failure to distribute Schedule K-1 to shareholders, partners or LLC members will result in significant inconvenience to them and may cause them to miscalculate their tax liability.

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