Sample Return 3 (SR3)
Information for Partnership Tax Return
with
Explanations and Completed Tax Forms
The Spicers and Bill’s Market
Facts
William Spicer is an 80 percent partner in Bill’s Market, a cash basis general partnership
located at 387 Spring Street, Raleigh, NC 29288. His wife, June, is the other 20 percent partner
although she is no longer active in the business. The Market’s EIN is 79-7979797 and its business
code is 445290, and it began business on July 15, 1993. During the last tax year, the Market had
the following results from its operations:
Gross sales
Beginning inventory (at cost)
Purchases
Ending inventory (at cost)
Expenses:
Advertising
Charitable contributions
Cleaning/maintenance
Depreciation (pre-2002 purchases)
Sec. 179 expense (6/1/02 display case)
FICA taxes
Health insurance
Insurance (excludes health)
Interest (accounts payable)
Licenses/fees
Meals/entertainment
Office expenses
Rent
Salary/wages
Travel
Utilities
$2,700,000
320,000
2,000,000
340,000
$40,000
2,000
12,000
3,000
5,000
18,000
15,000 *
18,000
1,000
4,000
1,000
14,000
120,000
210,000
8,000
16,000
*Includes $3,000 for health insurance for William and his family.
The market sold a unique piece of equipment for $13,000. It had originally cost $5,000 when
purchased on March 5, 2000; it had an adjusted basis of $3,000 when sold on August 15, 2002.
The market also sold a display case for $1,000 on December 12, 2002, which had cost $12,000
when purchased on June 6, 1998; it had an adjusted basis of $4,000 when sold.
The partnership agreement provides for a $150,000 guaranteed payment to William but none
for June since she is no longer active in the business; William takes drawings during the year that
are equivalent to the guaranteed payment.
The partnership’s beginning and ending accrual basis balance sheets for 2002 are shown
below:
January 1, 2003
December 31, 2003
Assets
Cash
Accounts Receivable
Inventory
Plant, Prop. and Equipment
Less: Accum. Depreciation
Total Assets
$ 62,000
37,500
320,000
$80,000
62,000
Liabilities and Equities
Note Payable
Capital--William
Capital--June
Total Liabilities and Equities
18,000
$437,500
$ 12,500
340,000
85,000
$437,500
$145,000
37,500
340,000
$68,000
63,000
5,000
$527,500
12,500
412,000
103,000
$527,500
The Spicers’ Income Tax Information
The Spicers live at 2345 Carolina Avenue, Durham, NC 27212. William’s Social
Security number is 123-45-6789 and June’s is 987-65-4321. They do not contribute to the
Presidential campaigns. They have two dependent children—Sophie is 9 (SS#333-33-3333) and
Carl is 4 (SS#444-44-4444).
The following information pertains to the completion of the Spicers’ personal tax return:
Interest income
$500
Dividend income
1,300
Loss on stock sale (long-term)
(14,000)
Unreimbursed doctor’s bills
$8,000
Unreimbursed hospital bills
12,000
Dental bills
2,000
Mortgage interest
14,000
Real estate taxes
4,000
Contributions to their church
1,500
June is a volunteer at the children’s school but otherwise does not work outside the home.
Her total mileage for her trips to and from the school was 1,200 miles. She also had unreimbursed
out-of-pocket expenses for teaching materials of $232. Additionally, she spent $1,500 on
childcare so that she could be there during after-school hours to tutor at-risk students. The Spicers
contribute $3,000 each to regular IRSs.
The Spicers made quarterly estimated tax payments of $65,000. All payments were made
when due.
The completed Form 1065 (pp. 1 and 2), Schedule D, Forms 4562 and 4797 for the
partnership and the K-1s for partners, William and June, and Form 1040, Schedules A, B, D, E,
and SE for the Spicers follow along with an explanation of various items.
Explanation
Two complete sets of tax returns must be prepared—one for the partnership, Form 1065, and
the other for the Spicers, Form 1040.
Form 1065 should be prepared first. Separately stated items of income and expense of the
partnership must be segregated from the balance of the income and expense items that will
constitute ordinary or “bottom line” income. The separately stated expense items are the
charitable contributions and the Section 179 expense. The health insurance premium paid by the
partnership for William and his family is considered a guaranteed payment to William. The net
Section 1231 gain is also a separately stated item. Note, however, that the Section 1245 recapture
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is an element of ordinary income for the partnership. It does not require separate reporting for
partnership purposes and is included in partnership ordinary income.
To complete the partnership tax return, the Section 1231 gain and loss and the Section 1245
recapture are both entered on Form 4797; only the Section 1231 net gain is separately reported on
Schedule K (Form 1065), line 6. The $2,000 depreciation recapture is reported as other income on
line 7, Form 1065. Form 4562 is completed for the partnership to report both the Section 179
expense and depreciation expense. The Section 179 expense is reported as a separate item on line
9 of the Schedule K, however. The annual limitation on the Section 179 expense applies at both
the partnership and partner level. The charitable contribution is subject to limitation at the partner
level and is separately reported on line 8, Schedule K.
The $3,000 payment for health insurance by the partnership for William is reported as part
of the guaranteed payment ($153,000) on line 10, p. 1, Form 1065. The guaranteed payment is
also reported on line 5, Schedule K.
To complete Schedule K, the earnings from self-employment are reported on line 15(a).
These earnings include ordinary income plus guaranteed payments reduced for the Section 179
expense and the $2,000 Section 1245 income. William’s guaranteed payments and share of
ordinary income (as adjusted) are subject to self-employment taxes. Because this is a general
partnership, June’s income is also subject to self-employment taxes even though she no longer
works actively in the business. If she were a limited partner, she would not be subject to selfemployment taxes on this income. Finally, the $500 of nondeductible meals/entertainment
expense is reported on line 21, Schedule K. This item is must be reported because it reduces the
partners’ outside bases in their partnership interests. (Note: the interest expense is not reported
separately as it is from accounts payable rather than interest incurred for investment purposes.)
The partnership then completes Schedule K-1s for William and June that include their share of
each of the items reported on Schedule K. These forms tie directly to the items reported on
Schedule K. Thus, William’s 80 percent and June’s 20 percent shares of net ordinary income is
reported on line 1, the Section 1231 gain on line 6, the charitable contribution is on line 8, the
Section 179 expense on line 9, and the nondeductible expense is on line 21. The guaranteed
payment (including the health insurance premium) is reported only on William’s line 5 and the
appropriate self-employment income is included line 15(a). William’s self-employment income
includes not only his share of the partnership ordinary income but includes the guaranteed
payment.
Form 1065 and Related Schedules and Forms
File Name
Forms Included
SR3f1065return.pdf Form 1065: U.S. Return of Partnership Income
Schedule K-1: Partner’s Share of Income (June)
Schedule K-1: Partner’s Share of Income (William)
Form 4562: Depreciation and Amortization
Form 4797: Sales of Business Property
Schedule of Other Deductions:
Bill's Market EIN: 79-7979797
Form 1065
Page 1, Line 20, Other deductions:
Advertising
Interest
Meals/entertainment@ 50%
Office expense
Travel
$40,000
1,000
500
14,000
8,000
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Insurance
Utilities
18,000
16,000
$97,500
Form 1040
Once the partnership return is complete, the Spicers’ personal tax return can be completed.
To complete their personal tax return, the Spicers’ must determine their AGI. They report their
interest and dividend income on Schedule B and enter these amounts on lines 8(a) and 9,
respectively, on Form 1040. The items listed on their K-1s are accounted for as follows: On page
2 of Schedule E they report their combined ordinary income from the partnership and William’s
guaranteed payment in Part II, column (k) and the Section 179 expense in column (j). Although
June is no longer active in the business, her income is still considered active income because of
William’s participation. The net amount from line 40 is entered on line 17, Form 1040. Because
the guaranteed payment for William’s health insurance is included in William’s income, it is
treated as paid by him. He is allowed to deduct 70 percent ($2,100) of the premium on line 28,
Form 1040. The remaining premium is included with their other medical expenses. They must
complete Schedule 4797 to report the net Section 1231 gain (entered on line 2 column (g) with
the notation that it is from Schedule K-1) and the Section 179 expense (entered on line 17).
Because there are no other Section 1231 gains or losses, this net gain is entered on line 11,
Schedule D and combined with the Spicers’ long-term capital gain and loss entered on line 8 for a
net $9,000 loss. They are permitted to deduct $3,000 of this loss and they have a $6,000 loss
carryover. The charitable contributions are included on Schedule A with their other charitable
contributions. The applicable net income from self-employment is entered on their respective
Schedule SEs to determine self-employment taxes and the allowable deduction for one-half this
amount on line 27, Form 1040. Their AGI of $221,763 is the sum of these items.
The Spicers can now complete their Schedule A and page 2 of Form 1040. Again, their
itemized deductions are reduced for 3 percent of their AGI in excess of $137,300. They deduct
their personal exemptions of $10,080 and the taxable income is $189,282. Their income tax is
$46,846 and they must add the self-employment taxes of $18,873, a total tax of 65,719. They
have no allowable credits. After deducting their estimated payments of $65,000, they owe $719 in
taxes. They do not owe any penalty on this underpayment as the amount owed is less than 10
percent of their tax total liability.
Form 1040 and Related Schedules
File Name
Forms Included
SR3f1040return.pdf Form 1040: U.S. Individual Income Tax Return
Schedule A: Itemized Deductions and
Schedule B: Interest and Dividends
Schedule D: Capital Gains and Losses
Schedule E: Income or Loss from Partnerships
Schedule SE: Self-Employment Tax (June)
Schedule SE: Self-Employment Tax (William)
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