1065 prep_10_book.indb

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MODULE 2 — SCHEDULES AND FORM COMPLETION
Schedules L, M-1, M-2 and M-3
(Page 4 of Form 1065)
5
LEARNING OBJECTIVES
SCHEDULE L
This chapter discusses Schedules L, M-1, M-2 and
M-3.
Schedule L reports the balance sheet items from the
partnership’s books and records. Inventories and other
assets should be the same in both places. Any differences between the partnership’s books and records and
Schedule L should be explained on an attachment to
the return.
Upon completion, you will be able to:
Complete these schedules
Identify when completion of these schedules is not
required
OVERVIEW OF SCHEDULES
Schedules L, M-1 and M-2 must be completed by the
partnership or LLC unless the entity answers “yes” to
question 5 of Schedule B. Question 5 is answered “yes”
if the partnership’s total receipts are less than $250,000,
the partnership’s total assets are less than $1 million, and
Schedules K-1 furnished to all partners are timely filed.
Thus, for example, small partnerships may be exempt
from having to complete the schedules on page 5 of Form
1065. They would also be exempt from reporting assets
on item F on page 1 of Form 1065, as well as completing
Item L on Schedule K-1.
Large partnerships (explained later) must complete
Schedule M-3.
1065 prep_10_book.indb 35
PRACTICE POINTER: Partnerships that report to any
national, state, municipal or other public officer may
attach a copy of their balance sheet prescribed by
any public officer in lieu of completing Schedule L.
PRACTICE POINTER: Look for differences where
property contributions have a different value than the
adjusted basis to the contributing partner so that they
can be explained on an attachment to the return.
In general, the balance sheet is rather straightforward,
and it should agree with the books.
Schedule L of Form 1065 is reproduced on the following page.
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36
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
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Schedule L
Balance Sheets per Books
Assets
1
2a
b
3
4
5
6
7
8
9a
b
10a
b
11
12a
b
13
14
15
16
17
18
19
20
21
22
Cash . . . . . . . . . . .
Trade notes and accounts receivable .
Less allowance for bad debts . . .
Inventories . . . . . . . . .
U.S. government obligations . . .
Tax-exempt securities
. . . . .
Other current assets (attach statement)
Mortgage and real estate loans
. .
Other investments (attach statement) .
Buildings and other depreciable assets
Less accumulated depreciation . .
Depletable assets . . . . . . .
Less accumulated depletion
. . .
Land (net of any amortization) . . .
Intangible assets (amortizable only) .
Less accumulated amortization
. .
Other assets (attach statement)
. .
Total assets . . . . . . . . .
Liabilities and Capital
.
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Accounts payable .
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.
.
Beginning of tax year
(a)
(b)
End of tax year
(c)
(d)
Mortgages, notes, bonds payable in less than 1 year
Other current liabilities (attach statement)
All nonrecourse loans . . . . . . .
.
.
Mortgages, notes, bonds payable in 1 year or more
Other liabilities (attach statement) .
Partners’ capital accounts . . .
Total liabilities and capital . . .
.
.
.
.
.
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.
.
.
Problem areas for Schedule L. Some key items that
might present problems include the following:
Line 5 of the balance sheet includes tax-exempt
securities. These include state and local government
obligations and shares in mutual funds that invest in
tax-exempt obligations.
Nonrecourse loans are shown on line 18 of the
balance sheet. Nonrecourse loans are loans of the
partnership for which none of the partners have any
personal liability.
STUDY QUESTIONS
1.
a. The partnership’s total receipts are less than
$250,000.
b. The partnership’s total assets are less than
$1 million.
c. Schedules K-1 are filed with the return and
timely furnished to partners.
d. All of the above.
2.
Assuming completion of the balance sheet is required, tax-exempt securities need not be entered.
True or False?
3.
Assuming completion of the balance sheet is required, when completing line 18, a limited liability
company includes:
PRACTICE POINTER: In the case of an LLC, all
liabilities are nonrecourse, unless personally guaranteed.
Remember that the total assets required to be reported
on line F on page 1 of Form 1065 are picked up from
line 14(d) of the balance sheet. Normally cash basis
partnerships will have no entries on Lines 2 (accounts
receivable and trade notes), 3 (inventories) and 15 (accounts payable).
1065 prep_10_book.indb 36
Every partnership is required to complete Schedule L unless:
a. Only recourse loans
b. Only nonrecourse loans that are personally
guaranteed by members
c. All loans unless personally guaranteed by
members
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MODULE 2 — CHAPTER 5 — Schedules L, M-1, M-2 and M-3
37
that have been paid or accrued may not be deductible
on a tax return.
NOTE: Answers to Study Questions, with feedback
to both the correct and incorrect responses, are provided in a special section beginning on page 85.
These and other differences need to be explained. This is
where Schedule M-1 comes in. Schedule M-1 reconciles
income or loss per books with income or loss per return.
SCHEDULE M-1
The books of the partnership are prepared in conformity
with the accepted rules of accounting practice. In many
cases, however, the treatment of various items differs
between financial accounting and tax accounting.
PRACTICE POINTER: If a partnership is not required
to complete the balance sheet, then it does not have
to complete Schedule M-1. If a large partnership
is required to complete Schedule M-3, it does not
complete Schedule M-1.
For example, income that is taken into account for financial accounting may receive tax-free treatment. Expenses
Schedule M-1 of Form 1065 is reproduced below.
p
Schedule M-1
1
2
Reconciliation of Income (Loss) per Books With Income (Loss) per Return
Note. Schedule M-3 may be required instead of Schedule M-1 (see instructions).
Net income (loss) per books . . . .
Income recorded on books this year not included
6
3
Guaranteed payments (other than
health insurance) . . . . . . .
4
Expenses recorded on books this year
not included on Schedule K, lines 1
through 13d, and 16l (itemize):
a Depreciation $
b Travel and entertainment $
5
1065 prep_10_book.indb 37
on Schedule K, lines 1 through 11 (itemize):
Income included on Schedule K, lines 1, 2, 3c,
5, 6a, 7, 8, 9a, 10, and 11, not recorded on
books this year (itemize):
Add lines 1 through 4 .
.
.
.
.
Tax-exempt interest $
a
Deductions included on Schedule K, lines
1 through 13d, and 16l, not charged
against book income this year (itemize):
Depreciation $
7
8
9
.
a
Add lines 6 and 7 . . . . . . . .
Income (loss) (Analysis of Net Income
(Loss), line 1). Subtract line 8 from line 5 .
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1. Accounting Income. Enter on line 1 the net income
from the partnership’s books as of the close of the year.
This is called accounting income.
2-5. Increases to Accounting Income
1. Increase accounting income by the following:
Line #
Income Type
Source of Information
2
Income included on Schedule K that is not recorded
on the books.
Items not on the
books but included
in the lines indicated
at Line 2 of Schedule
M-1.
Line 10, page 1 of
Form 1065, which
excludes health insurance coverage.
Individual items deducted on the books
but not deducted on
the tax return in the
lines indicated at Line
4 of Schedule M-1.
3
4
Partner income represented
by guaranteed payments
other than health insurance
provided to partners
Expenses recorded on the
books but not included on
Schedule K
NOTE: All Line 4
deductions should be
itemized on a separate schedule, with
the total agreeing
with Line 4.
4a
4b
1065 prep_10_book.indb 38
Book depreciation that is not
deductible
Other additions. Examples
of book deductions to be
added back here include:
The nondeductible portion
of meals and entertainment (including 50% of
the meals and entertainment non deductible for
tax purposes or excessive
reimbursements for these
costs)
The nondeductible cost of
club dues
The nondeductible cost of
spousal travel
Expenses for the use of
entertainment facilities that
are not deductible
The cost of tickets in
excess of face value
Nondeductible business
gifts in excess of $25
Expenses of conventions
on cruises in excess of
$2,000
Employee awards in excess of $400
The part of the cost of
skyboxes that exceeds
the face value of the nonluxury box seat tickets
2. On Line 5, enter the total of lines 1 through 4(b) of
Schedule M-1.
6. Income Recorded on Books, Not Entered on Schedule K. Enter the total of the income items recorded on
the books not included on Lines 1 through 7 of Schedule
K. Examples of income listed here include tax-exempt
interest and other tax-free income (such as proceeds from
key person life insurance policies).
7. Deductions Included on Schedule K, Not Charged
Against Book Income. List the deductions included on
Schedule K but not charged against book income (e.g.,
depreciation and other items not charged against book
income that were listed on the lines indicated at Line 6
of Schedule M-1).
PRACTICE POINTER: Be sure to itemize these ex-
penses.
8. Total. Total
the amounts on lines 6 and 7.
9. Income or Loss. Subtract line 8 from line 5, and enter
the remainder on line 9.
PRACTICE POINTER: This should equal Item 1 in
the Analysis of Net Income (Loss) at the top of page
5 of the Form 1065.
STUDY QUESTIONS
4.
With respect to Schedule M-1, the entry on line 1
for net income (loss) per books means:
a. Gross income
b. Taxable income
c. Accounting income
5.
With respect to Schedule M-1, accounting income
is increased by all of the following except:
a. Depreciation that is not deductible
b. 50% of meal costs that are not deductible
c. Health insurance provided to partners
SCHEDULE M-2, ANALYSIS OF PARTNERS’
CAPITAL ACCOUNTS
The purpose of Schedule M-2 (reproduced on the following page) is to show the causes of any changes in the
capital accounts of the partners. Beginning and ending
capital accounts should agree with the partnership’s
books and records, with the balance sheet entries, and
with the totals of amounts reported on Schedule K-1,
11/6/2009 3:30:07 PM
MODULE 2 — CHAPTER 5 — Schedules L, M-1, M-2 and M-3
39
g
Schedule M-2
1
2
Analysis of Partners’ Capital Accounts
3
4
Balance at beginning of year .
Capital contributed: a Cash
.
b Property
Net income (loss) per books . .
Other increases (itemize):
.
.
.
.
.
.
.
.
5
Add lines 1 through 4 .
.
.
.
.
.
Item L, which is the breakdown of each partner’s capital
account. This schedule need not be completed if neither
Schedule L nor Schedule M-1 was required.
The rules for determining capital accounts can be found
in the regulations (Reg. §1.704-1(b)(2)(iv)).
PITFALL: Do not use the rules used for determining
capital accounts for figuring the basis of a partner’s
interest.
6
.
.
.
.
.
.
.
.
7
Distributions: a Cash
. .
b Property .
Other decreases (itemize):
8
9
Add lines 6 and 7 .
.
.
.
.
Balance at end of year. Subtract line 8 from line 5
.
.
.
1 of Form 1065 to indicate that it is a voluntary filer.
For tax years ending on or after December 31, 2008, if
Schedule M-3 is filed, then questions must be answered
on Schedule C, Additional Information for Schedule M-3
Filers, of Form 1065.
The purpose of this schedule is to increase transparency
in income tax return filings by providing a more detailed
reconciliation between financial accounting net income
and taxable income than had been required in the past.
A large partnership is a partnership with any of the following qualities:
PRACTICE POINTER: Some practitioners employ
supplementary capital and asset accounts where the
regulations require capital accounts to reflect values
rather than basis.
For example, the book value of an asset would be the
sum of two accounts: One account might be labeled
“Asset A – Basis,” and any required adjustment might
be labeled “Asset A – Sec. 704(b) Adjustment.”
The line-by-line completion of Schedule M-2 is straightforward.
Adjust the beginning balance for certain items during
the year. For example, increases are made for such items
as capital contributions and net income per books.
Decreases are made for distributions. The increases and
decreases should balance out.
Be sure to explain on a separate attachment any discrepancies between the beginning balance and the balance
at the end of the previous year.
STUDY QUESTION
6.
The purpose of Schedule M-2 is to show what
caused any changes in the partners’ capital accounts. True or False?
$10 million or more in total assets at the end of the
tax year
$10 million or more in adjusted total assets at the
end of the tax year
$35 million or more in total receipts
50% or more owned by a taxpayer other than itself
is required to file Schedule M-3
PRACTICE POINTER: For the first year in which
Schedule M-3 is filed, completion of certain portions
is optional.
PRACTICE POINTER: There are important changes
on the Schedule M-3 used in tax years ending on or
after December 31, 2008. For instance, the partnership must indicate the accounting standard used for
reporting worldwide consolidated net income or loss
(GAAP, IFRS, 704(b), tax-basis, or other).
Large partnerships that complete Schedule M-3 do not
have to complete Schedule M-1.
Schedule M-3 of Form 1065 is reproduced on the following pages.
STUDY QUESTION
SCHEDULE M-3
Large partnerships are required to file Schedule M-3. A
partnership that is not a large partnership can choose
to file Schedule M-3 and should check line E on page
1065 prep_10_book.indb 39
7.
Every partnership required to file Schedules L, M-1
and M-2 must also complete Schedule M-3. True
or False?
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
SCHEDULE M-3
(Form 1065)
Department of the Treasury
Internal Revenue Service
Name of partnership
Net Income (Loss) Reconciliation
for Certain Partnerships
Attach to
See
Form 1065 or Form 1065-B.
separate instructions.
OMB No. 1545-0099
2009
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Employer identification number
This Schedule M-3 is being filed because (check all that apply):
A
The amount of the partnership’s total assets at the end of the tax year is equal to $10 million or more.
B
The amount of the partnership’s adjusted total assets for the year is equal to $10 million or more. If box B is checked,
.
enter the amount of adjusted total assets for the tax year
C
The amount of total receipts for the taxable year is equal to $35 million or more. If box C is checked, enter the total
.
receipts for the tax year
D
An entity that is a reportable entity partner with respect to the partnership owns or is deemed to own an interest of 50
percent or more in the partnership’s capital, profit, or loss, on any day during the tax year of the partnership.
Name of Reportable Entity Partner
Identifying Number
Maximum Percentage Owned or
Deemed Owned
E
Voluntary Filer
Part I
1a
b
c
2
3a
b
4a
b
5a
b
6a
b
7a
b
8
9
10
11
12
a
b
c
d
Financial Information and Net Income (Loss) Reconciliation
Did the partnership file SEC Form 10-K for its income statement period ending with or within this tax year?
Yes. Skip lines 1b and 1c and complete lines 2 through 11 with respect to that SEC Form 10-K.
No. Go to line 1b. See instructions if multiple non-tax-basis income statements are prepared.
Did the partnership prepare a certified audited non-tax-basis income statement for that period?
Yes. Skip line 1c and complete lines 2 through 11 with respect to that income statement.
No. Go to line 1c.
Did the partnership prepare a non-tax-basis income statement for that period?
Yes. Complete lines 2 through 11 with respect to that income statement.
No. Skip lines 2 through 3b and enter the partnership’s net income (loss) per its books and records on line 4a.
/
/
Ending
/
/
Enter the income statement period: Beginning
Has the partnership’s income statement been restated for the income statement period on line 2?
Yes. (If “Yes,” attach an explanation and the amount of each item restated.)
No.
Has the partnership’s income statement been restated for any of the five income statement periods preceding the period on line 2?
Yes. (If “Yes,” attach an explanation and the amount of each item restated.)
No.
4a
Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1
Indicate accounting standard used for line 4a (see instructions):
2
3
1
GAAP
IFRS
704(b)
Other: (Specify) 4
5
Tax-basis
)
5a (
Net income from nonincludible foreign entities (attach schedule) . . . . . . . . . . . . .
5b
Net loss from nonincludible foreign entities (attach schedule and enter as a positive amount) . . .
)
6a (
Net income from nonincludible U.S. entities (attach schedule)
. . . . . . . . . . . . .
6b
Net loss from nonincludible U.S. entities (attach schedule and enter as a positive amount) . . . .
7a
Net income (loss) of other foreign disregarded entities (attach schedule) . . . . . . . . . .
7b
Net income (loss) of other U.S. disregarded entities (attach schedule) . . . . . . . . . . .
Adjustment to eliminations of transactions between includible entities and nonincludible entities
8
(attach schedule) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9
Adjustment to reconcile income statement period to tax year (attach schedule) . . . . . . . .
10
Other adjustments to reconcile to amount on line 11 (attach schedule) . . . . . . . . . . .
Net income (loss) per income statement of the partnership. Combine lines 4 through 10 . . .
11
Note. Part I, line 11, must equal the amount on Part II, line 26, column (a).
Enter the total amount (not just the partnership’s share) of the assets and liabilities of all entities included or removed on the following lines:
Total Assets
Total Liabilities
Included on Part I, line 4
Removed on Part I, line 5
Removed on Part I, line 6
Included on Part I, line 7
For Paperwork Reduction Act Notice, see the Instructions for your return.
1065 prep_10_book.indb 40
Cat. No. 39669D
Schedule M-3 (Form 1065) 2009
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MODULE 2 — CHAPTER 5 — Schedules L, M-1, M-2 and M-3
41
Version A, Cycle 1
Schedule M-3 (Form 1065) 2009
Page
Employer identification number
Name of partnership
Part II
2
Reconciliation of Net Income (Loss) per Income Statement of Partnership with Income (Loss) per
Return
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Income (Loss) Items
(a)
Income (Loss) per
Income Statement
(b)
Temporary
Difference
(c)
Permanent
Difference
(d)
Income (Loss) per
Tax Return
(Attach schedules for lines 1 through 9)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21a
Income (loss) from equity method foreign corporations
Gross foreign dividends not previously taxed . . .
Subpart F, QEF, and similar income inclusions
. .
Gross foreign distributions previously taxed . . .
Income (loss) from equity method U.S. corporations
U.S. dividends . . . . . . . . . . . . .
Income (loss) from U.S. partnerships . . . . . .
Income (loss) from foreign partnerships . . . . .
Income (loss) from other pass-through entities
. .
Items relating to reportable transactions (attach details)
Interest income (attach Form 8916-A) . . . . .
Total accrual to cash adjustment . . . . . . .
Hedging transactions . . . . . . . . . . .
Mark-to-market income (loss) . . . . . . . .
Cost of goods sold (attach Form 8916-A) . . . . (
Sale versus lease (for sellers and/or lessors) . . .
Section 481(a) adjustments . . . . . . . . .
Unearned/deferred revenue . . . . . . . . .
Income recognition from long-term contracts . . .
Original issue discount and other imputed interest .
)
(
)
Income statement gain/loss on sale, exchange,
abandonment, worthlessness, or other disposition of
assets other than inventory and pass-through entities .
b Gross capital gains from Schedule D, excluding
amounts from pass-through entities . . . . . .
c
Gross capital losses from Schedule D, excluding
amounts from pass-through entities, abandonment
losses, and worthless stock losses . . . . . .
d Net gain/loss reported on Form 4797, line 17,
excluding amounts from pass-through entities,
abandonment losses, and worthless stock losses
.
e Abandonment losses . . . . . . . . . . .
f Worthless stock losses (attach details) . . . . .
g Other gain/loss on disposition of assets other than inventory
22
Other income (loss) items with differences (attach schedule)
23
Total income (loss) items. Combine lines 1 through
22 . . . . . . . . . . . . . . . . .
24
Total expense/deduction items. (from Part III, line
30) (see instructions) . . . . . . . . . . .
25
Other items with no differences
. . . . . . .
26
Reconciliation totals. Combine lines 23 through 25
Note. Line 26, column (a), must equal the amount on Part I, line 11, and column (d) must equal Form 1065, page 5, Analysis of
Net Income (Loss), line 1.
Schedule M-3 (Form 1065) 2009
1065 prep_10_book.indb 41
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42
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Version A, Cycle 1
Schedule M-3 (Form 1065) 2009
Page
Employer identification number
Name of partnership
Part III
Reconciliation of Net Income (Loss) per Income Statement of Partnership With Income (Loss) per
Return—Expense/Deduction Items
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0
(a)
Expense per
Income Statement
Expense/Deduction Items
1
2
3
4
5
6
7
8
9
10
11
12
13
State and local current income tax expense .
State and local deferred income tax expense .
Foreign current income tax expense (other
foreign withholding taxes) . . . . . . .
Foreign deferred income tax expense . . .
Equity-based compensation
. . . . . .
Meals and entertainment . . . . . . . .
Fines and penalties . . . . . . . . .
Judgments, damages, awards, and similar costs
Guaranteed payments
. . . . . . . .
Pension and profit-sharing . . . . . . .
Other post-retirement benefits . . . . . .
Deferred compensation . . . . . . . .
Charitable contribution of cash and tangible
property . . . . . . . . . . . . .
14
15
3
(b)
Temporary
Difference
(c)
Permanent
Difference
(d)
Deduction per
Tax Return
. .
. .
than
. .
. .
. .
. .
. .
. .
. .
. .
. .
. .
.
.
Charitable contribution of intangible property . . .
Organizational expenses as per Regulations
section 1.709-2(a) . . . . . . . . . . . .
16
Syndication expenses as per Regulations
section 1.709-2(b) . . . . . . . . . . . .
17
Current year acquisition/reorganization investment
banking fees . . . . . . . . . . . . . .
18
Current year acquisition/reorganization legal and
accounting fees . . . . . . . . . . . . .
19
Amortization/impairment of goodwill . . . . . .
20
Amortization of acquisition, reorganization, and
start-up costs . . . . . . . . . . . . .
21
Other amortization or impairment write-offs
. . .
22
Section 198 environmental remediation costs . . .
23a Depletion—Oil & Gas . . . . . . . . . . .
b Depletion—Other than Oil & Gas . . . . . . .
24
Intangible drilling & development costs . . . . .
25
Depreciation . . . . . . . . . . . . . .
26
Bad debt expense . . . . . . . . . . . .
27
Interest expense (attach Form 8916-A) . . . . .
28
Purchase versus lease (for purchasers and/or
lessees) . . . . . . . . . . . . . . .
29
Other expense/deduction items with differences
(attach schedule) . . . . . . . . . . . .
30
Total expense/deduction items. Combine lines 1
through 29. Enter here and on Part II, line 24,
reporting positive amounts as negative and negative
amounts as positive . . . . . . . . . . .
Schedule M-3 (Form 1065) 2009
1065 prep_10_book.indb 42
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MODULE 2 — SCHEDULES AND FORM COMPLETION
6
Schedule K (Page 3 of Form 1065)
LEARNING OBJECTIVES
This chapter will enable participants to gain an understanding of Schedule K.
Upon completion, you will be able to:
Explain and identify separately-stated pass-through
items
Complete Schedule K
OVERVIEW OF SCHEDULE K
Schedule K, which appears on page 4 of Form 1065, is
used to report:
Ordinary income (loss)
All separately stated items of income, deductions,
gains or losses, and credits that are passed through
to the partners
Schedule K reports the entire amount of these items.
The amounts from Schedule K are then allocated among
Schedule K
Income (Loss)
1
2
1065 prep_10_book.indb 43
the partners on Schedule K-1 to permit the partners to
report their respective shares of those items on their own
income tax returns.
Schedule K must be filed by all partnerships, regardless of the amount of the partnership’s assets or
gross receipts. Schedule K itself is broken down into
a number of sections, such as income, deductions,
and credits.
STUDY QUESTION
1.
Schedule K does not need to be filed by certain
small partnerships. True or False?
NOTE: Answers to Study Questions, with feedback
to both the correct and incorrect responses, are provided in a special section beginning on page 85.
Schedule K of Form 1065 is reproduced below.
Partners’ Distributive Share Items
Ordinary business income (loss) (page 1, line 22) . . . . . .
Net rental real estate income (loss) (attach Form 8825) . . . .
3a
3a Other gross rental income (loss) . . . . . . . .
b Expenses from other rental activities (attach statement) .
3b
c Other net rental income (loss). Subtract line 3b from line 3a . .
4
Guaranteed payments
. . . . . . . . . . . . . .
5
Interest income . . . . . . . . . . . . . . . . .
6
Dividends:
a Ordinary dividends . . . . . . . . . .
6b
. . . . . .
b Qualified dividends
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Royalties . . . . . . . . . . . . . . . . . . .
8
Net short-term capital gain (loss) (attach Schedule D (Form 1065))
9a Net long-term capital gain (loss) (attach Schedule D (Form 1065))
b Collectibles (28%) gain (loss) . . . . . . . . .
9b
c Unrecaptured section 1250 gain (attach statement) . .
9c
10
Net section 1231 gain (loss) (attach Form 4797) . . . . . .
11
Other income (loss) (see instructions) Type Total amount
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44
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
SCHEDULE K (FORM 1065)
INCOME (LINES 1-11)
The first section in Schedule K reports all income items.
Fill out the information as follows:
Enter ordinary
income or loss from the partnership’s trade or business
activities from page 1, line 22, of Form 1065. If the
partnership reports a loss on line 22 of Form 1065, list
the full amount of the loss on line 1 of Schedule K.
Do not limit the amount by the partners’ bases, at-risk
amounts, or otherwise, as these limitations are applied
at the partner level.
1. Ordinary Business Income or Loss.
PITFALL: Do not include rental activity income or loss
or portfolio income or loss on line 1 of Schedule K.
These items are reported elsewhere on Schedule K.
2. Net Rental Real Estate Income. Enter the amount of
net income or loss from Form 8825, Rental Real Estate Income
and Expenses of a Partnership or an S Corporation. Form
8825 should be attached to the return. If the partnership
has more than one rental real estate activity for purposes
of the passive activity limitations, attach to the return a
statement showing the amount of income or loss from
each activity. Note that such activities do not necessarily
correspond to the columns on Form 8825. If there is a loss
from a low-income housing project, identify on Schedule
K-1 whether the partner is a qualified investor within the
meaning of Section 502 of the Tax Reform Act of 1986.
3a. Other Gross Rental Income. Enter the gross rental
income from other rental activities. Include in this amount
income or loss from other activities where amounts are
paid for the use of property held by the partnership. The
term rental activities is more fully defined in temporary
regulations (Temp. Reg. §1.469-1T(e)(3)).
Do not include rentals where the average rental period is
seven days or less or where the average period of customer
use is 30 days or less or where extraordinary personal services are provided. Also, do not include as a rental activity
any rental that is treated as incidental to a non-rental
activity or where the partnership makes the property
available for the nonexclusive use of customers.
In determining gross income from other rental activities,
be sure to include ordinary gain or loss from the sale,
exchange, or involuntary conversion of an asset used in
a rental activity other than a rental real estate activity.
Essentially, this means pick up from line 18 of Form
4797 any ordinary income reported on that form, such
as depreciation recapture.
1065 prep_10_book.indb 44
3b. Expenses From Other Rental Activities. Enter
expenses related to the rental activity or activities, whose
income is reported on line 3a. Attach a schedule to the
return that explains these amounts.
3c. Other Net Rental Income or Loss. Net income or
loss from other rental activities is the difference between
lines 3a and 3b. Enter this amount on line 3c.
PRACTICE POINTER: If an amount is related to more
than one activity, attach a statement showing the
amount from each activity.
The passive activity loss rules make it necessary to report
income or loss from rental activities separate from trade
or business income. Partners determine their ability to
claim these losses at the partner level. In one case, an LLC
member was permitted to aggregate his participation in
the LLC with his previous participation in a Corporation (engaged in a similar line of business) to establish
material participation. Losses passed through could be
characterized as ordinary losses (Gregg, DC OR, 2001-1
USTC ¶50,169).
STUDY QUESTION
2.
Gross income from rental real estate activities
includes all of the following except:
a. Gain or loss from an involuntary conversion
of a rental property.
b. Income from a rental activity treated as inci-
dental to a nonrental activity.
c. Amounts paid for the rental of partnership
property.
4. Guaranteed Payments. Include on line 4 of Schedule
K the following types of payments to or on behalf of
the partners:
Health insurance coverage for the partners, their
spouses, and dependents (Rev. Rul. 91-26, 1991-1
CB 184).
Interest or salary deducted by the partnership that
was reported on line 10, page 1 of Form 1065,
plus payments required to be capitalized. For
example, payments for services rendered by the
partners in the organization of the partnership
or in a syndication effort were not deductible on
page 1 because such amounts are required to be
capitalized. However, they are entered on line 4 as
income to the partners.
11/6/2009 3:30:10 PM
MODULE 2 — CHAPTER 6 — Schedule K
PRACTICE POINTER: Guaranteed payments listed on
line 4 are not treated as passive activity income.
Guaranteed payments to partners are also treated as
self-employment income for purposes of self-employment taxes. They are added to other net earnings such
as ordinary income or loss from trade or business and
included on line 14 of Schedule K-1.
5. Interest Income. Report on line 5 taxable interest in-
come of the partnership. Interest income must be reported
separately because individual partners use this information in figuring their investment interest deduction.
6a-b. Dividends. In view of the preferential tax rates
applied to qualified dividends for noncorporate taxpayers, Schedule K provides space for separating ordinary
dividends from qualified dividends. More specifically,
report ordinary dividends on line 6a and qualified dividends on line 6b.
45
PRACTICE POINTER: By separately stating divi-
dends, individual partners can elect on their own
income tax returns whether to treat dividend income
as subject to ordinary income tax rates for purposes
of the net investment income limitation on investment interest. Corporate partners may qualify for the
dividends received deduction.
7. Royalties.
Report on line 7 royalties received by the
partnership.
8. Net Short-Term Capital Gain or Loss. A partnership
reports capital gains and losses on Schedule D (Form 1065),
Capital Gains and Losses. The purpose of Schedule D (Form
1065) is to separate short-term from long-term transactions.
These net short-term and long-term capital gains and losses
can then be passed through separately to the partners, who
use these amounts to compute their capital gains and losses
on their income tax returns. Line 8 on Schedule D (Form
1065) is used to report short-term and long-term gain (loss)
from like-kind exchanges. This is gain that is picked up from
Form 8824 and arises when boot (i.e., non-like-kind property)
is involved in the exchange.
Schedule D (Form 1065) is reproduced on the following page.
1065 prep_10_book.indb 45
11/6/2009 3:30:11 PM
46
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
SCHEDULE D
(Form 1065)
Department of the Treasury
Internal Revenue Service
Name of partnership
Part I
Capital Gains and Losses
OMB No. 1545-0099
2009
Attach to Form 1065. See separate instructions.
Use Schedule D-1 to list additional transactions for lines 1 and 7.
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Employer identification number
Short-Term Capital Gains and Losses—Assets Held One Year or Less
(a) Description of property
(Example: 100 shares
of “Z” Co.)
1
(b) Date acquired
(month, day, year)
(c) Date sold
(month, day, year)
(d) Sales price
(see instructions)
(e) Cost or other basis
(see instructions)
2
Enter short-term capital gain or (loss), if any, from Schedule D-1, line 2
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3
Short-term capital gain from installment sales from Form 6252, line 26 or 37 .
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Short-term capital gain (loss) from like-kind exchanges from Form 8824 .
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5
Partnership’s share of net short-term capital gain (loss), including specially allocated shortterm capital gains (losses), from other partnerships, estates, and trusts . . . . . . .
5
Net short-term capital gain or (loss). Combine lines 1 through 5 in column (f). Enter here and
on Form 1065, Schedule K, line 8 or 11 . . . . . . . . . . . . . . . . . .
6
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(f) Gain or (loss)
Subtract (e) from (d)
Part II Long-Term Capital Gains and Losses—Assets Held More Than One Year
(a) Description of property
(Example: 100 shares
of “Z” Co.)
(b) Date acquired
(month, day, year)
(c) Date sold
(month, day, year)
(d) Sales price
(see instructions)
(e) Cost or other basis
(see instructions)
(f) Gain or (loss)
Subtract (e) from (d)
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8
Enter long-term gain or (loss), if any, from Schedule D-1, line 8 .
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9
Long-term capital gain from installment sales from Form 6252, line 26 or 37 .
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11
Partnership’s share of net long-term capital gain (loss), including specially allocated long-term
capital gains (losses), from other partnerships, estates, and trusts . . . . . . . . .
11
12
Capital gain distributions .
12
13
Net long-term capital gain or (loss). Combine lines 7 through 12 in column (f). Enter here
and on Form 1065, Schedule K, line 9a or 11 . . . . . . . . . . . . . . . .
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For Paperwork Reduction Act Notice, see the Instructions for Form 1065.
1065 prep_10_book.indb 46
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Cat. No. 11393G
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Schedule D (Form 1065) 2009
11/6/2009 3:30:11 PM
MODULE 2 — CHAPTER 6 — Schedule K
9a. Net Long-Term Capital Gain or Loss. Like shortterm gains and losses, net long-term capital gains and
losses are computed on Schedule D (Form 1065). Generally, net long-term capital gains and losses are reported
on line 9a of Schedule K.
If there is any special allocation of long-term capital gains
(an allocation in a ratio that is different from the ratio for
sharing income and loss), report the specially-allocated
net long-term gain on line 9a of Schedule K (box 9a
of Schedule K-1 is sued to show the partner’s specially
allocated gain and the partner’s distributive share of the
net long-term gain from Schedule D.
9b. Collectibles Gain or Loss. On this line, report net
long-term capital gain or loss subject to the 28% rate
from transactions relating to disposing of collectibles
and Section 1202 stock.
Report net
long-term capital gain subject to the 25% rate on unrecaptured Section 1250 gain.
9c. Unrecaptured Section 1250 Gain.
Schedule D (Form 1065) contains space for listing shortterm and long-term transactions. Column (f ) is used for
listing the amount of gains and losses. The partnership
is not required to compute the maximum tax on net
capital gain, nor is it required to apply any capital loss
limitation or capital loss carryover because these items are
determined at the partner level. Other gains, such as gain
on the sale of Section 1202 stock should be separately
shown on line 11, or line 20 of the Schedule K.
PRACTICE POINTER: Partnerships can elect to roll
over gain realized on the sale of qualified small business stock by buying other qualified small business
stock within 60 days of the original sale.
Partnerships using the cash method of accounting may
be able to sell property on the installment method. For
reporting on the installment method, the partnership
must complete Form 6252, Installment Sale Income. Thus,
the partnership decides whether or not to use this installment method. If the partnership elects out of installment
reporting, the entire gain is reported on Schedule D.
If a note or other obligation is received, and it is being reported at less than face value, make that notation in the margin.
Enter the face amount and the percentage of valuation.
10. Net Section 1231 Gain or Loss. Enter Code Section
1231 gain or loss other than from a casualty or theft on
line 10 of Schedule K. Code Section 1231 gains and
losses of a partner will be combined with the partner’s
other such gains and losses to ultimately determine the
treatment of those gains and losses.
1065 prep_10_book.indb 47
47
In determining the amount to enter on line 10, first
compute the amount of gain or loss on Form 4797, Sales
of Business Property. If the partnership has more than one
activity, attach a statement to the return explaining to
which activity the gain or loss relates. Then, enter the
result on line 6 of Schedule K.
STUDY QUESTION
3.
Partners can elect out of installment reporting with
respect to their distributive share of capital gains
from a sale by the partnership. True or False?
11. Other Income or Loss. This line is the catchall line
for income or loss not reported elsewhere on Schedule K.
Amounts reported on line 11 include gain or loss from
involuntary conversions due to casualty or theft. If the
partnership experienced a casualty or theft loss, then
Form 4684, Casualties and Thefts, must be completed
and attached to the partnership return. If the casualty
or theft involved property not used in the trade or business, then the partnership does not need to complete the
form. Instead, the partnership should merely notify the
partners and have them personally complete the form
with respect to their share of the gain or loss.
Examples of other income or loss include:
Gain from depreciation recapture. This is income
reported on Form 4797.
Net gain or loss from involuntary conversions due to
casualty or theft. The amount reported on Schedule K is
first computed on Form 4684, Casualties and Thefts.
Net gains or losses from Section 1256 contractions.
The amount reported on Schedule K is computed
on Form 6781, Gains and Losses From Section 1256
Contracts and Straddles.
Gain from the disposition of an interest in oil, gas, geothermal, or other mineral properties. Gain or loss from
contracts or straddles. If the partnership has such other
income, be sure to complete and attach Form 6781, Gains
and Losses From Section 1256 Contracts and Straddles.
Recovery of tax benefit items (Code Sec. 111)
Gambling income
Income, gain, or loss from a distribution to a partner
(Code Sec. 751(b))
Any specially allocated ordinary income or loss (special
allocations are detailed in the partnership agreement)
PRACTICE POINTER: Attach a separate schedule
explaining the type and amount of other income or
loss reported on line 11.
11/6/2009 3:30:11 PM
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
Deductions
48
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13a
b
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(
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Section 179 deduction (attach Form 4562) . .
Contributions . . . . . . . . . . .
Investment interest expense
. . . . . .
(1) Type Section 59(e)(2) expenditures:
Other deductions (see instructions) Type SCHEDULE K (FORM 1065)
DEDUCTIONS (LINES 12-13)
Deductions that receive special treatment are entered
separately on Schedule K.
The Deductions portion of Schedule K (Form 1065) is
reproduced above.
12. Section 179 Deductions. The first-year expense election
is made by the partnership (Code Sec. 179). The election is
made on Part I, Form 4562, Depreciation and Amortization,
and is then entered on line 12 of Schedule K.
However, while the election is made by the partnership,
the first-year expense dollar limitation and the taxable
income limitation are applied at both the partnership and
partner levels. A partnership is a taxpayer under the regulations that impose these limits even though a partnership
can never itself be a taxpaying entity (Hayden, CA-7,
2000-1 USTC ¶50,219, aff ’g 112 TC 115 (1999)).
The increased dollar limit on first-year expensing for
2009 is $250,000. If Congress does not extend the increased limit, then in 2010, the limit is set to revert to
$125,000. (With an adjustment for inflation); expect
the limit to be about $135,000.) After 2010, the dollar
limit on first-year expensing is scheduled to revert back
to its original $25,000 amount. This lower limit will
be adjusted for inflation.
In addition the first-year expensing can be increased by
$35,000 for qualified enterprise zone property placed
in service by an enterprise zone business (Code Sec.
1397A). For a listing of geographic areas where the increased deduction can be claimed, see IRS Publication
954, Tax Incentives for Empowerment Zones and Other
Distressed Communities. Portions of the District of Columbia are also treated as qualifying for the increased
dollar limit on first-year expensing. Special dollar limits
apply to certain storm victims (e.g., Hurricane Katrina
and the Midwest disaster area).
In 2009, the basic dollar limit begins to phase out dollarfor-dollar when a partnership buys Section 179 property
totaling more than $800,000. Thus, no expensing can
be claimed if the partnership places in service more than
$1,050,000 or more of Section 179 property for the year.
1065 prep_10_book.indb 48
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(2) Amount 13c(2)
13d
EXAMPLE: A partnership places in service $1 million
of Section 179 property in 2009. The maximum Section
179 deduction that the partnership can elect in 2009 is
$50,000 ($250,000 - [$1,000,000- $800,000]).
The first-year expense deduction may not exceed taxable
income derived from the active conduct by the taxpayer
of any trade or business during the taxable year. The dollar limits and taxable income limit each apply at both
the partnership and partner levels.
PRACTICE POINTER: When partners own interests
in other businesses, be sure to coordinate expense
deductions.
For instance, if a partner owns a sole proprietorship
or owns another partnership interest, then it may turn
out that the expense deductions passed through to
the partner will not be able to be fully utilized.
There is no carryover when a partner exceeds the
dollar limitation, even though the partner’s basis must
be reduced by the deduction passed through.
PRACTICE POINTER: For purposes of the taxable
income limitation, a partner should not take into
account the deduction for one-half of any selfemployment tax.
Even if the first-year expense deductions may not be fully
utilized, the partner’s adjusted basis in the partnership
interest is reduced by the partner’s distributive share of the
expense deduction even though the partner is prohibited
from deducting all or a portion of such expenses because of
the dollar limitation (Rev. Rul. 89-7, 1989-1 CB 178).
EXAMPLE: A, a 50% partner in the AB partnership, is also
a sole proprietor of another business. In 2009, when the
maximum first-year expense deduction was $250,000,
AB claimed it placed in service equipment worth
$250,000 for which it elected first-year expensing.
One-half of the deduction was passed through
to A. A also claimed a full $250,000 first-year expense deduction for her sole proprietorship. A can
only claim a deduction of $250,000 on her individual
return even though total first-year expense deductions passed through to her were $375,000, the
$125,000 from the partnership and the $250,000
from the sole proprietorship.
11/6/2009 3:30:11 PM
MODULE 2 — CHAPTER 6 — Schedule K
STUDY QUESTION
4.
All of the following statements about first-year
expensing are correct except:
a. The basic dollar limit for 2009 is $250,000.
b. The dollar limit applies at both the partner-
ship and partner levels.
49
STUDY QUESTION
5.
The partnership must inform the partners as to
what portion of charitable contributions made
by the partnership qualifies for the 50%, 30%,
and 20% limit on their individual tax returns.
True or False?
c. The dollar limit applies only at the partner level.
13a. Contributions. If the partnership made any chari-
table contributions during the year, enter the amount on
line 13a. If donations are $250 or more, the partnership
must have obtained contemporaneous written acknowledgments from the charity in order to claim deductions.
Written acknowledgments obtained by the due date of
the return are treated as being contemporaneous.
Substantiation. Donations of cash in any amount must
be substantiated by a written acknowledgment from the
charity or a bank statement. For noncash contributions
over $500, the partnership must complete Form 8283,
Noncash Charitable Contributions. In addition, special
rules apply to vehicle donations. Specifically, unless the
charity retains or substantially improves the vehicle,
the donation is limited to the sales proceeds received
by the charity.
Donations that exceed $5,000 require an appraisal as
part of substantiation. If the partnership fails to obtain
required substantiation, the deduction for the donation
will be disallowed at the partner level.
Each partner should be given a copy of Form 8283 if a
group of similar items of property exceed $5,000, even
if the amount allocated to a particular partner is less
than $5,000. If the form is not required to be given to a
partner, then the partnership should provide an itemized
list showing what portion of the contribution is subject
to the 50%, 30%, and 20% limits.
In other words, the partnership must show what contributions were made in cash, and are eligible for the
50%-of-adjusted-gross income limit on the partner’s
individual return; what contributions were gifts of appreciated long-term capital gain property and eligible for the
30% limit; and what contributions were gifts to private
non-operating foundations subject to a 20% limit.
PRACTICE POINTER: Any time the allowance of an
item of income, deduction, or credit must be computed by reference to limitations on the partner’s
tax return, the partner’s share of such item must be
separately set forth on the partnership return.
1065 prep_10_book.indb 49
13b. Investment Interest Expense. Investment interest
expense is reported separately on line 13b of Schedule K
to enable individual partners to compute their allowable
investment interest deduction on Form 4952, Investment
Interest Expense Deduction.
For purposes of determining investment income, the IRS
has ruled that an LLC’s accounts receivable are not subject to investment interest limitations because accounts
receivable are not property held for investment (TAM
200010004). However, cash bank accounts are held
primarily for investment, so income from such accounts
can be used to figure deductible investment interest.
Noncorporate limited partners’ distributive share of interest expense on indebtedness allocable to the partnership’s
securities trading business is investment interest that is
subject to limitation if the partners do not materially
participate in the trading activity (Code Sec. 163(d)(1);
Rev. Rul. 2008-12, IRB 2008-10, 520).
However, interest paid or accrued on indebtedness allocable to property held for investment is a trade or business
deduction, after application of the limit, and is used to
determine the partners’ adjusted gross income (Rev. Rul.
2008-38, IRB 2008-31, 439). Passive partners in trading
partnerships take their interest expense deduction on
Schedule E rather than as an itemized deduction on Schedule A (Announcement 2008-65, IRB 2008-31, 279).
Line 13c is used
to report expenditures subject to a Code Section 59(e)
election, which is the optional 10-year write-off for
certain preferences. This election is not made by the
partnership. Rather, it is available to each individual
partner. Section 59(e)(2) defines a qualified expenditure
as any amount that, but for an election under section
59(e), would have been allowed as a deduction for the
taxable year in which paid or incurred under Section 173
(relating to circulation expenditures), Section 174 (relating to research and experimental expenditures), Section
263(c) (relating to intangible drilling and development
expenditures), Section 616(a) (relating to development
expenditures), or Section 617(a) (relating to mining
exploration expenditures). The type of expenditure is
entered on line 13c(1); the amount of the expenditure
is entered on line 13c(2).
13c. Section 59(e)(2) Expenditures.
11/6/2009 3:30:12 PM
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
13d. Other Deductions. Line 13d is used as a catchall
line for entering deductions for which there is no separate
line. Be sure to attach a separate schedule detailing these
other deductions.
income from the partnership’s income that is subject to
self-employment taxes.
As previously mentioned, partners are not considered
employees of the partnership even if they perform services.
Instead, they are self-employed individuals who, in many
cases, are subject to self-employment taxes. In general,
self-employment tax is imposed on a general partner’s
distributive share of net income from a trade or business
plus any guaranteed payments to the general partner.
The various types of other deductions to enter on line
13d include:
Amounts that would be itemized by the partners if
they had paid them directly
Penalty on early withdrawal from time deposit accounts or CDs
Soil and water conservation expenditures (Code
Sec. 175)
Expenditures for the removal of architectural and transportation barriers to the elderly and handicapped (Code Sec.
190). The election to deduct these costs, up to $15,000
per year, is made by the partnership. However, the dollar
limit applies at both the partnership and partner levels.
According to the regulations, a partner must combine his
or her distributive share of the partnership’s deductible
expenditures, after application of the dollar limit at the
partnership level, with any individual expenditures, and
apply the dollar limit to the combined total (Reg. §1.1901(b)). The partner may allocate the dollar limit among his
or her own expenditures and his or her distributive share of
the partnership’s expenditures. If this allocation results in all
or a portion of the partner’s distributive share not being an
allowable deduction by the partner, the partnership may
capitalize the unallowable amount by an adjustment to the
basis of the relevant partnership property.
Medical insurance paid on behalf of the partners, their
spouses, and their dependents. Separately stating this
amount on Schedule K, and for each partner on Schedule
K-1 allows the partners to determine their personal health
insurance deduction on their individual returns.
Payments for a partner’s IRA, SEP, SIMPLE, or other
self-employed qualified retirement plans. Schedule
K lists only the contributions made on behalf of the
partners, who will, in turn, deduct them on their individual returns. Contributions to such plans on behalf
of common-law employees were already deducted on
line 18 of Form 1065 (page 1).
Interest expense allocated to debt-financed distributions (IRS Notice 89-35, 1989-1 CB 675)
Periodic payments made by a partnership to a retired partner are excluded from self-employment income provided
such payments are made pursuant to a written plan that
provides benefits for partners generally, or to a class or
classes of partners (Code Sec. 1402(a)(13)). In appropriate cases, the regulations state that a class of partners may
include only one member of the partnership.
Code Section 1402(a)(13) also excludes from selfemployment tax a limited partner’s share of partnership
income other than guaranteed payments for services.
A general partner may not claim exemption from selfemployment tax because he lacked control over the
partnership and spent only a minimal amount of time on
partnership business (Norwood, TC Memo 2000-84).
The IRS had issued two different sets of amendments to
proposed regulations that would clarify the definition of
limited partners (see e.g., Amendment to Reg. §1.1402(a)18 REG-209824-96; 1/16/97). This would have had the
effect of clarifying when members in LLCs are subject to
self-employment tax.
However, imposition of regulations was subject to a
moratorium until July 1, 1998. At the time this course
was prepared, the IRS still had not issued any further
guidance. According to the IRS, the intent behind their
proposed regulations is that an individual’s net earnings
from self-employment amounts that are demonstrably
returns on capital invested in the partnership should be
excluded from self-employment tax.
PRACTICE POINTER: It would seem that members
who are more like limited partners according to old
regulations still in effect need not pay self-employment tax. It might be prudent to bifurcate a partner’s
interest into general and limited partnership interests,
provided the limited interest was identical to that of
other limited partners. However, recent court cases
have determined that LLC members are not like limited partners for purposes of the passive activity loss
rules; the reasoning of these court decisions could
be applied to the self-employment tax area.
SCHEDULE K (FORM 1065)
SELF-EMPLOYMENT INCOME (LINES 14A-C)
14a. Net Earnings or Loss from Self-Employment.
6
0
SelfEmployment
Enter the net earnings or loss from self-employment.
The purpose of this entry is to isolate that portion of the
1065 prep_10_book.indb 50
(
)
yp
14a Net earnings (loss) from self-employment .
b Gross farming or fishing income . . . .
c Gross nonfarm income . . . . . . .
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14b
14c
11/6/2009 3:30:12 PM
MODULE 2 — CHAPTER 6 — Schedule K
The IRS has ruled that an LLC member was subject to
self-employment tax on his distributive share of income
where a general partnership converted to LLC status
(Letter Ruling 9432018).
In reporting net earnings or loss from self-employment,
there are several points to keep in mind. Since limited
partners generally are not subject to self-employment tax
on their distributive share of net income from a trade or
business, do not include on line 14a:
Income allocable to limited partners, other than guaranteed payments for services actually rendered
Interest and dividends unless they are received in the
course of the trade or business, such as in the case of
a dealer in stocks or securities
Income from an S corporation, even though the
owner actively participates in the business (Ding, TC
Memo 1997-435; Letter Ruling 9530005)
Income from the operation of a group investment
program
Rentals from real estate are not treated as self-employment income, unless they are received in the course of the
trade or business (Reg. §1.1402(a)-4(c)(2)). Thus, a real
estate dealer would treat such rentals as self-employment
income. Whether one is engaged in such a trade or
business depends on the extent of services rendered to
occupants. Services are considered rendered to occupants
if they are primarily for the occupants’ convenience and
are other than those usually and customarily rendered
in connection with the rental of rooms or other space
for occupancy only.
51
In one case, a lawyer was a partner in a partnership that
operated a self-storage rental activity. The attorney could
not offset his professional fees by his distributive share of
rental activity losses since the partnership failed to provide substantial services (Hopper, 94 TC 542 (1990)).
The same treatment applies to royalty income that is not
treated as self-employment income, unless it is received
in the course of the trade or business.
PRACTICE POINTER: The IRS has ruled on the im-
pact of the passive activity loss rules for purposes
of self-employment tax.
According to the ruling, passive activity losses from a
partnership can be taken into account in figuring selfemployment tax to the extent that such losses are
currently deductible under the passive loss rules.
Moreover, prior year passive activity losses can be
taken into account for self-employment tax purposes
to the extent they are deductible in the current year
(TAM 9750001).
If a partnership makes a contribution to a health savings
account on behalf of a partner who renders services to the
partnership, the contribution is treated as a guaranteed
payment and is included in the partner’s gross income
subject to self-employment tax (Notice 2005-8, IRB
2005-4, 368).
Net earnings are determined on the Worksheet for Figuring
Net Earnings (Loss) from Self-Employment, included in the
IRS instructions to Form 1065 (reproduced below).
Worksheet for Figuring Net Earnings (Loss) From Self-Employment
1a Ordinary business income (loss) (Schedule K, line 1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1a
b Net income (loss) from certain rental real estate activities (see instructions) . . . . . . . . . . . . . . . . .
1b
c Other net rental income (loss) (Schedule K, line 3c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1c
d Net loss from Form 4797, Part II, line 17, included on line 1a above. Enter as a positive amount . . .
1d
e Combine lines 1a through 1d . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
1e
2
Net gain from Form 4797, Part II, line 17, included on line 1a above . . . . . . . . . . . . . . . . . . . . . .
3a Subtract line 2 from line 1e. If line 1e is a loss, increase the loss on line 1e by the amount on line 2
b Part of line 3a allocated to limited partners, estates, trusts, corporations, exempt organizations, and
IRAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
2
3a
3b
c Subtract line 3b from line 3a. If line 3a is a loss, reduce the loss on line 3a by the amount on line 3b. Include each individual
general partner’s share in box 14 of Schedule K-1, using code A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4a Guaranteed payments to partners (Schedule K, line 4) derived from a trade or business as defined in
section 1402(c) (see instructions) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4a
b Part of line 4a allocated to individual limited partners for other than services and to estates, trusts,
corporations, exempt organizations, and IRAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
4b
c Subtract line 4b from line 4a. Include each individual general partner’s share and each individual limited partner’s share in box
14 of Schedule K-1, using code A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5
Net earnings (loss) from self-employment. Combine lines 3c and 4c. Enter here and on Schedule K, line 14a . . . . . . . . . . . .
1065 prep_10_book.indb 51
3c
4c
5
11/6/2009 3:30:13 PM
52
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
PRACTICE POINTER: Do not assume that simply be-
cause a partner is inactive, he or she is exempt from
self-employment tax. An inactive general partner is
still required to pay self-employment tax on business
income (Cokes, 91 TC 222 (1988)).
Also, an inactive general partner in an activity that
elected out of partnership reporting is still subject to
self-employment tax (Johnson, TC Memo 1990-461).
15a and 15b. Low Income Housing Credit. Report the
partnership’s low-income housing credit. The amount
of the credit from Code Sec. 42(j)(5) is reported on line
15a. All other low-income housing credit is reported
on line 15b. (See Code Section 42(j)(5) for when the
partnership is treated as the taxpayer for purposes of the
low-income housing credit).
15c. Qualified Rehabilitation Expenditures. Report the
farming or fishing income.
partnership’s qualified rehabilitation expenditures for rental
real estate. If an amount is entered on line 15c, Form 3468,
Investment Credit, needs to be attached to the return.
14c. Gross Nonfarm Income. Report gross income from
15d. Other Rental Real Estate Credits.
14b. Gross Farming or Fishing Income.
Report gross
non-farming activities.
Report any
other credits related to rental real estate activities.
STUDY QUESTION
15e. Other Rental Credits.
6.
Which of the following is exempt from selfemployment tax on his/her distributive share of
entity income?
a. General partner
b. Limited partner
c. Limited liability company member who works
for the business
SCHEDULE K (FORM 1065) CREDITS
AND CREDIT RECAPTURE
(LINE 15A-F)
Credits are broken down into two main categories:
1. Credits relating to real estate (Lines 15a through 15e)
2. All other credits (Line 15f )
Credits
The Credits portion of Form 1065 is reproduced below.
1065 prep_10_book.indb 52
15a
b
c
d
e
f
Credits related to other
rental activities (Line 15e). Enter any other credits related
to rental activities other than rental real estate activities
on this line.
15f. Other Credits. Report all other credits not previously
reported on Schedule K. If an amount is entered on line
15f, a schedule describing the entry must be attached to
the partnership return. It may also be necessary to include
a required form for a particular credit being claimed.
Examples of credits reported on line 15f include:
Employment credits
There is the work opportunity credit (Form 5884),
empowerment zone and renewal community employment credit (Form 8844), the Indian employment credit
(Form 8845), the employer Social Security credit for
FICA on tips (Form 8846), and the credit for employer
differential wage payments to activated reservists (Form
8932). There is no limit on the number of employees
that can qualify for any of these credits.
Low-income housing credit (section 42(j)(5)) . . . . . . . . . .
Low-income housing credit (other)
. . . . . . . . . . . . .
Qualified rehabilitation expenditures (rental real estate) (attach Form 3468)
Type Other rental real estate credits (see instructions)
Type Other rental credits (see instructions)
Other credits (see instructions)
Type .
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15b
15c
15d
15e
15f
11/6/2009 3:30:13 PM
MODULE 2 — CHAPTER 6 — Schedule K
Disabled access credit (Form 8826)
This credit is only available to small businesses. For
purposes of this credit, small businesses are those with
gross receipts in the preceding year not in excess of $1
million or those that did not employ more than 30 fulltime employees during the preceding year.
Other credits include:
Foreign Transactions
Energy efficient home credit for builders (Form 8908)
Energy efficient appliance credit for manufacturers
(Form 8909)
Alternative motor vehicle credit (Form 8910)
Alternative fuel vehicle refueling property credit
(Form 8911)
Enhanced oil recovery credit (Form 8830)
Renewable electricity, Refined Coal, and Indian Coal
production credit (Form 8835)
Orphan drug credit (Form 8820)
Credit for contributions to selected community development corporations (Form 8847)
Qualified electric vehicle credit (Form 8834)
Nonconventional source fuel credit. This credit is
figured at the partnership level and apportioned to
those who were partners on the last day of the tax year.
Show the computation on a separate schedule.
Unused credits from cooperatives are also apportioned
only to those who were partners on the last day of
the tax year
Credit for increasing research activities for expenses
(Form 6765)
Credit for alcohol used as fuel (Form 6478). However,
when reporting this credit on Schedule K-1, this
credit is apportioned only to those who were partners
on the last day of the tax year. Also, this credit is
included in income on line 7, page 1 of Form 1065.
The limitation for small producers is applied at both
the partnership and partner levels. The partnership
can elect not to have the credit apply. Such an election
must be made before the expiration of the three-year
period beginning on the due date of the return for
the tax year in which the alcohol was used as fuel,
1065 prep_10_book.indb 53
53
without regard to any extensions (Code Sec. 40(f )).
The manner for making the election is supposed to
be spelled out in regulations, but to date there have
not been any such regulations.
Credit for income tax withheld. This credit applies
if the partnership is subject to back-up withholding
on interest and dividends.
Credit for plan start-up expenses of small employers (those who employed 100 or fewer employees in
the prior year) (Form 8881). The credit is 50% of
administrative and education-related expenses up to
$1,000 (top credit of $500) for each of the first three
years of a qualified retirement plan.
Credit for employer-provided child care expenses
(Form 8882). The credit is 25% of childcare expenses
plus 10% of referral expenses for a total credit each
year of up to $150,000.
New markets credit (Form 8874)
Biodiesel fuels credit (Form 8864)
Low sulfur diesel fuel production credit (Form 8896)
Railroad track maintenance credit (Form 8900)
Agricultural chemicals security credit (Form 8931)
Also include on line 15f any credit recapture.
SCHEDULE K (FORM 1065)
FOREIGN TRANSACTIONS (LINE 16)
Separate reporting is required to permit the individual
partners to figure their foreign tax credit or to claim
a deduction for such taxes on their own tax returns.
Information related to foreign taxes is entered on lines
16a through 16n.
Schedule K requires the reporting of all information
necessary to permit the partners to figure the foreign tax
credit or deduction. If there are taxes with respect to one
foreign country only, simply enter the required information on Schedule K. When there is more than one country
involved, attach a separate schedule for each country.
The Foreign Transactions portion of Form 1065 is reproduced below.
(
)
yp
16a Name of country or U.S. possession b Gross income from all sources . . . . . . . . . . . . . . . . . . .
c Gross income sourced at partner level . . . . . . . . . . . . . . . .
Foreign gross income sourced at partnership level
e General category d Passive category f Other Deductions allocated and apportioned at partner level
g Interest expense h Other . . . . . . . . . . Deductions allocated and apportioned at partnership level to foreign source income
j General category i Passive category k Other . . . . . . . .
l Total foreign taxes (check one): Paid
Accrued
m Reduction in taxes available for credit (attach statement) . . . . . . . . . .
n Other foreign tax information (attach statement) . . . . . . . . . . . . .
16b
16c
16f
16h
16k
16l
16m
11/6/2009 3:30:14 PM
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
Alternative
Minimum Tax
(AMT) Items
54
g
Post-1986 depreciation adjustment . . . . .
b Adjusted gain or loss . . . . . . . . . .
c Depletion (other than oil and gas) . . . . . .
d Oil, gas, and geothermal properties—gross income
e Oil, gas, and geothermal properties—deductions .
f Other AMT items (attach statement) . . . . .
17a
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17b
17c
17d
17e
17f
SCHEDULE K (FORM 1065)
OTHER INFORMATION (LINES 18-20)
SCHEDULE K (FORM 1065)
ALTERNATIVE MINIMUM TAX (AMT) ITEMS
(LINE 17)
This section is used to report any other item that requires separate treatment by the partners. Other items
are entered on lines 18a through 20c.
Since a partnership is not a taxpayer, it does not have
any alternative minimum tax liability. Adjustments and
tax preferences used in computing AMT pass through
to the partners, who determine the amount of AMT on
their respective returns. Adjustments and tax preference
items are listed on line 17a through 17f.
The Other Information portion 1065 is reproduced
below.
18a. Tax-Exempt Interest Income. Report tax-exempt
interest income. Individuals must report such income
on their returns even though it may not affect their
taxation.
The AMT Items portion of Form 1065 is reproduced
above.
Partners are permitted to make an optional 10-year
write-off of certain preference items. This election is
not made by the partnership. Therefore, items subject to
this optional election are not reported along with other
adjustments and tax preference items. Instead, they are
reported separately on Schedule K.
STUDY QUESTION
7.
Tax-exempt interest earned by a partnership is
reported as follows:
a. Because it is not taxable, it is not included on
the partnership’s return.
Report accelerated depreciation of property
placed in service after 1986.
b. It is reported on page 1 of Form 1065.
c. It is reported on Schedule K in the other
Line 17a.
information section.
Line 17b. Report adjusted gain or loss resulting from the
sale of property where the basis for regular tax purposes
is different from the basis for AMT purposes due to past
depreciation differences.
Report other taxexempt income (income exempt from tax other than
tax-free interest).
18b. Other Tax-exempt Income.
Line 17c. Report depletion other than from gas and oil.
18c. Nondeductible Expenses. Report nondeductible
expenses.
Report gross income allocable to oil, gas or
geothermal properties.
Line 17d.
19a. Distributions of Cash and Marketable Securities. Report distributions of money (defined as cash and
Report deductions allocable to oil, gas and
geothermal properties.
Line 17e.
certain marketable securities).
Other Information
Line 17f. Enter all other adjustments and preferences.
If any entries are made on this line, attach a schedule
to explain them.
1065 prep_10_book.indb 54
18a
b
c
19a
b
20a
b
c
Tax-exempt interest income . . . . . . .
Other tax-exempt income . . . . . . .
Nondeductible expenses . . . . . . . .
Distributions of cash and marketable securities
Distributions of other property . . . . . .
Investment income . . . . . . . . . .
Investment expenses . . . . . . . . .
Other items and amounts (attach statement) .
19b. Distributions of Other Property. Report distribu-
tions of property other than money.
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19a
19b
20a
20b
11/6/2009 3:30:15 PM
MODULE 2 — CHAPTER 6 — Schedule K
Report investment income
(defined as gross income from property held for investment in excess of any net capital gain from the disposition of such property). Generally, investment income
does not include income from passive activities. Property
subject to a net lease is treated as a passive activity and,
so, is not included as investment income.
20a. Investment Income.
Report investment expenses (defined as all expenses directly connected to the
production of income, other than interest).
20b. Investment Expenses.
Report other items
and amounts required to be reported separately to the
partners. These other items and amounts should be
explained on a schedule attached to the return.
20c. Other Items and Amounts.
NOTE: Information relevant to the domestic production activities deduction, which is entered on
Schedule K-1, is found in Chapter 7.
Examples of some other items and amounts required to be
reported separately include:
Taxes paid on undistributed capital gains by a regulated investment company
Number of gallons of each fuel used during the tax
year and the appropriate rate for each
Partners’ share of items necessary to figure depletion
for oil and gas
Qualified exploratory costs
Any recapture of the first-year expense deduction
under Code Sec. 179
Information necessary to determine the limitation
on the allowance of losses from the partnership (e.g.,
information about the partners’ bases in the partnership) (Code Sec. 704(d))
Information necessary to comply with the registration
of tax shelters or the disclosure of tax information
Share of farm production costs
Interest on installment obligations and information to
permit the partners to figure interest on the disposition of installment obligations
55
Special information with respect to certain long-term
contracts
Information required for capitalization under Code
Section 263A (IRS Notice 88-99, 1988-2 CB 422)
Information required if a partner has tax-exempt
status
Expenditures related to the rehabilitation credit (not
related to rental real estate activities), energy credit
and the reforestation credit
Recapture of the investment credit
Any other information (e.g., special information
required where a partner has a pension plan)
SCHEDULE K (FORM 1065)
ANALYSIS OF NET INCOME OR LOSS
(LINES 1-2B)
The last section on Schedule K is on the top of page 5 of
Form 1065 and is called Analysis of Net Income (Loss).
It is used to report the total income or loss reported on
Schedule K and to provide an analysis of this income by
the type of partner in the partnership.
The Analysis of Net Income (Loss) portion of Form 1065
is reproduced below.
Combine the income items in
the first section of Schedule K and subtract the deduction items. This will give you an income or loss figure,
which will agree with line 9 of Schedule M-1.
1. Net Income or Loss.
Analyze this income
or loss for the different types of partners. These include
both general and limited.
2a-b. Analysis by Partner Type.
PRACTICE POINTER: Presumably the same type
of distinction should be made in an LLC between
a member-manager and a member who could be
viewed as a limited partner.
The breakdown is then made for corporate and individual partners, both active and passive, any partnerships that are partners, and exempt organizations
and nominees.
Analysis of Net Income (Loss)
1
2
Net income (loss). Combine Schedule K, lines 1 through 11. From the result, subtract the sum of
Schedule K, lines 12 through 13d, and 16l . . . . . . . . . . . . . . . . . .
1
Analysis by
(ii) Individual
(iii) Individual
(v) Exempt
(i) Corporate
(iv) Partnership
(active)
(passive)
organization
partner type:
a General partners
b Limited partners
1065 prep_10_book.indb 55
f
o
(vi)
Nominee/Other
11/6/2009 3:30:17 PM
1065 prep_10_book.indb 56
11/6/2009 3:30:17 PM
MODULE 2 — SCHEDULES AND FORM COMPLETION
Schedule K-1
LEARNING OBJECTIVES
This chapter will give participants an understanding
of Schedule K-1, which is used to allocate items to
partners.
Upon completion, you will be able to:
Complete Schedule K-1
Understand basis limitations
Explain the impact of liabilities on basis
OVERVIEW OF SCHEDULE K-1 (FORM 1065)
Schedule K-1 puts the pass-through nature of Form
1065 into operation. Schedule K-1 parallels Schedule
K. However, Schedule K reports each item of income,
deduction, loss and credit of the partnership, Schedule
K-1 indicates the partner’s share of the various items
discussed in Schedule K.
In general, Schedule K-1 is completed by applying each
partner’s distributive share to the amounts reported on
Schedule K. Schedule K-1 also indicates specifically
where on the Form 1040 or other forms or schedules
the pass-through amount should be reflected.
1065 prep_10_book.indb 57
7
Generally, partners must report items on their personal
returns exactly as they appear on Schedule K-1 (and in
the location indicated in the instructions to partners that
accompany Schedule K-1).
If partners want to apply a different treatment or amount
for a particular item, the partner should file Form 8082,
Notice of Inconsistent Treatment or Administrative Adjustment Request (AAR). Filing this form probably invites an
IRS examination of the partner’s personal return. However, it will protect the partner from accuracy-related
penalties imposed for disregard of rules or substantial
understatement of tax.
PRACTICE POINTER: The IRS has tried to use a
computer-matching program to cross check entries
on Schedule K-1 against entries on partners’ individual returns.
The program is similar to computer matching used
for W-2s and 1099s. However, it is unclear whether
it is operational or successful yet in matching information.
Schedule K-1 of Form 1065 is reproduced on the following pages.
11/6/2009 3:30:17 PM
58
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
651109
Final K-1
Schedule K-1
(Form 1065)
Part III
2009
Department of the Treasury
Internal Revenue Service
For calendar year 2009, or tax
Information About the Partnership
A
Partnership’s employer identification number
B
Partnership’s name, address, city, state, and ZIP code
Net rental real estate income (loss)
3
Other net rental income (loss)
4
Guaranteed payments
5
Interest income
6a
Ordinary dividends
6b
Qualified dividends
Credits
16
Foreign transactions
7
Royalties
8
Net short-term capital gain (loss)
9a
Net long-term capital gain (loss)
17
Alternative minimum tax (AMT) items
9b
Collectibles (28%) gain (loss)
9c
Unrecaptured section 1250 gain
10
Net section 1231 gain (loss)
18
Tax-exempt income and
nondeductible expenses
11
Other income (loss)
12
Section 179 deduction
19
Distributions
13
Other deductions
20
Other information
Information About the Partner
Partner’s identifying number
F
Partner’s name, address, city, state, and ZIP code
G
General partner or LLC
member-manager
Limited partner or other LLC
member
H
Domestic partner
Foreign partner
I
What type of entity is this partner?
J
Partner’s share of profit, loss, and capital (see instructions):
Beginning
Ending
Profit
%
%
Loss
%
%
Capital
%
%
Partner’s share of liabilities at year end:
Nonrecourse
.
.
$
Qualified nonrecourse financing
.
$
Recourse
.
$
.
$
Current year increase (decrease)
.
$
Withdrawals & distributions
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.
$ (
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$
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14
.
Capital contributed during the year
Ending capital account .
Tax basis
.
GAAP
Self-employment earnings (loss)
*See attached statement for additional information.
Partner’s capital account analysis:
Beginning capital account .
$
)
Section 704(b) book
Other (explain)
M
2
15
Check if this is a publicly traded partnership (PTP)
E
L
Ordinary business income (loss)
IRS Center where partnership filed return
Part II
K
1
For IRS Use Only
D
Partner’s Share of Current Year Income,
Deductions, Credits, and Other Items
, 2009
, 20
Partner’s Share of Income, Deductions,
See back of form and separate instructions.
Credits, etc.
C
OMB No. 1545-0099
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ending
Part I
Amended K-1
Did the partner contribute property with a built-in gain or loss?
Yes
No
If "Yes", attach statement (see instructions)
For Paperwork Reduction Act Notice, see Instructions for Form 1065.
1065 prep_10_book.indb 58
Cat. No. 11394R
Schedule K-1 (Form 1065) 2009
11/6/2009 3:30:17 PM
MODULE 2 — CHAPTER 7 — Schedule K-1
Schedule K-1 (Form 1065) 2009
59
2
Page
This list identifies the codes used on Schedule K-1 for all partners and provides summarized reporting information for partners who file Form 1040.
For detailed reporting and filing information, see the separate Partner’s Instructions for Schedule K-1 and the instructions for your income tax return.
1. Ordinary business income (loss). Determine whether the income (loss) is
passive or nonpassive and enter on your return as follows.
Report on
See the Partner’s Instructions
Passive loss
Passive income
Schedule E, line 28, column (g)
Nonpassive loss
Schedule E, line 28, column (h)
Nonpassive income
Schedule E, line 28, column (j)
2. Net rental real estate income (loss) See the Partner’s Instructions
3. Other net rental income (loss)
Net income
Schedule E, line 28, column (g)
Net loss
See the Partner’s Instructions
4. Guaranteed payments
Schedule E, line 28, column (j)
5. Interest income
Form 1040, line 8a
6a. Ordinary dividends
Form 1040, line 9a
6b. Qualified dividends
Form 1040, line 9b
Schedule E, line 4
7. Royalties
8. Net short-term capital gain (loss)
Schedule D, line 5, column (f)
Schedule D, line 12, column (f)
9a. Net long-term capital gain (loss)
28% Rate Gain Worksheet, line 4
9b. Collectibles (28%) gain (loss)
(Schedule D instructions)
9c. Unrecaptured section 1250 gain
See the Partner’s Instructions
10. Net section 1231 gain (loss)
See the Partner’s Instructions
11. Other income (loss)
Code
A Other portfolio income (loss)
See the Partner’s Instructions
B Involuntary conversions
See the Partner’s Instructions
C Sec. 1256 contracts & straddles
Form 6781, line 1
D Mining exploration costs recapture See Pub. 535
E Cancellation of debt
Form 1040, line 21 or Form 982
See the Partner’s Instructions
F Other income (loss)
12. Section 179 deduction
See the Partner’s Instructions
13. Other deductions
A Cash contributions (50%)
B Cash contributions (30%)
C Noncash contributions (50%)
See the Partner’s
D Noncash contributions (30%)
E Capital gain property to a 50%
Instructions
organization (30%)
F Capital gain property (20%)
G Contributions (100%)
H Investment interest expense
Form 4952, line 1
I Deductions—royalty income
Schedule E, line 18
J Section 59(e)(2) expenditures
See the Partner’s Instructions
K Deductions—portfolio (2% floor)
Schedule A, line 23
L Deductions—portfolio (other)
Schedule A, line 28
M Amounts paid for medical insurance Schedule A, line 1 or Form 1040, line 29
N Educational assistance benefits
See the Partner’s Instructions
O Dependent care benefits
Form 2441, line 14
P Preproductive period expenses
See the Partner’s Instructions
Q Commercial revitalization deduction
See Form 8582 instructions
from rental real estate activities
See the Partner’s Instructions
R Pensions and IRAs
S Reforestation expense deduction
See the Partner’s Instructions
T Domestic production activities
See Form 8903 instructions
information
U Qualified production activities income Form 8903, line 7
V Employer’s Form W-2 wages
Form 8903, line 15
See the Partner’s Instructions
W Other deductions
14. Self-employment earnings (loss)
Note. If you have a section 179 deduction or any partner-level deductions, see the
Partner’s Instructions before completing Schedule SE.
A Net earnings (loss) from
Schedule SE, Section A or B
self-employment
See the Partner’s Instructions
B Gross farming or fishing income
C Gross non-farm income
See the Partner’s Instructions
15. Credits
A Low-income housing credit (section
See the Partner’s Instructions
42(j)(5)) from pre-2008 buildings
B Low-income housing credit (other)
See the Partner’s Instructions
from pre-2008 buildings
C Low-income housing credit (section
42(j)(5)) from post-2007 buildings
Form 8586, line 11
D Low-income housing credit (other)
from post-2007 buildings
Form 8586, line 11
E Qualified rehabilitation
expenditures (rental real estate)
See the Partner’s Instructions
F Other rental real estate credits
G Other rental credits
H Undistributed capital gains credit
Form 1040, line 70; check box a
I Alcohol and cellulosic biofuel fuels
Form 6478, line 7
credit
J Work opportunity credit
Form 5884, line 3
其
其
1065 prep_10_book.indb 59
Code
Report on
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L
16.
Disabled access credit
See the Partner’s Instructions
Empowerment zone and renewal
Form 8844, line 3
community employment credit
M Credit for increasing research activities See the Partner’s Instructions
N Credit for employer social security
Form 8846, line 5
and Medicare taxes
O Backup withholding
Form 1040, line 61
P Other credits
See the Partner’s Instructions
Foreign transactions
A Name of country or U.S.
possession
Form 1116, Part I
B Gross income from all sources
C Gross income sourced at
partner level
Foreign gross income sourced at partnership level
D Passive category
Form 1116, Part I
E General category
F Other
Deductions allocated and apportioned at partner level
G Interest expense
Form 1116, Part I
Form 1116, Part I
H Other
Deductions allocated and apportioned at partnership level to foreign source
income
I Passive category
Form 1116, Part I
J General category
K Other
Other information
L Total foreign taxes paid
Form 1116, Part II
Form 1116, Part II
M Total foreign taxes accrued
N Reduction in taxes available for credit Form 1116, line 12
O Foreign trading gross receipts
Form 8873
P Extraterritorial income exclusion
Form 8873
Q Other foreign transactions
See the Partner’s Instructions
Alternative minimum tax (AMT) items
A Post-1986 depreciation adjustment
See the Partner’s
B Adjusted gain or loss
Instructions and
C Depletion (other than oil & gas)
the Instructions for
D Oil, gas, & geothermal—gross income
Form 6251
E Oil, gas, & geothermal—deductions
F Other AMT items
Tax-exempt income and nondeductible expenses
A Tax-exempt interest income
Form 1040, line 8b
B Other tax-exempt income
See the Partner’s Instructions
C Nondeductible expenses
See the Partner’s Instructions
Distributions
A Cash and marketable securities
See the Partner’s Instructions
B Distribution subject to section 737
C Other property
Other information
A Investment income
Form 4952, line 4a
B Investment expenses
Form 4952, line 5
C Fuel tax credit information
Form 4136
D Qualified rehabilitation expenditures
See the Partner’s Instructions
(other than rental real estate)
E Basis of energy property
See the Partner’s Instructions
F Recapture of low-income housing
Form 8611, line 8
credit (section 42(j)(5))
G Recapture of low-income housing
Form 8611, line 8
credit (other)
H Recapture of investment credit
See Form 4255
I Recapture of other credits
See the Partner’s Instructions
J Look-back interest—completed
See Form 8697
long-term contracts
K Look-back interest—income forecast
See Form 8866
method
L Dispositions of property with
section 179 deductions
M Recapture of section 179 deduction
N Interest expense for corporate
partners
O Section 453(l)(3) information
P Section 453A(c) information
Q Section 1260(b) information
See the Partner’s
R Interest allocable to production
Instructions
expenditures
S CCF nonqualified withdrawals
T Depletion information—oil and gas
U Amortization of reforestation costs
V Unrelated business taxable income
W Precontribution gain (loss)
X Section 108(i) information
Y Other information
其
其
17.
18.
19.
20.
其
其
其
11/6/2009 3:30:18 PM
60
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
STUDY QUESTION
1.
Schedule K-1 puts into effect the pass-through
nature of Form 1065. True or False?
NOTE: Answers to Study Questions, with feedback
to both the correct and incorrect responses, are provided in a special section beginning on page 85.
DISTRIBUTIVE SHARE
A partner must take into account his or her distributive
share of income, gain, loss, deductions, or credit for the
partnership year terminating within or at the end of his
or her tax year—whether or not such is distributed to
the partner.
The distributive share is simply the partner’s percentage of each item reported on Schedule K and usually is
determined by the partnership agreement.
EXAMPLE: Adams and Bradley form the AB Partnership. Their agreement states that everything will be
split 50-50. In this case, Adams’ distributive share of
the items reported on Schedule K is 50%.
Therefore, Adams’ Schedule K-1 would show 50%
of the totals reported on Schedule K. This would be
repeated for Bradley’s Schedule K-1.
A partner’s distributive share is based on the partner’s
interest in the partnership if the allocation to the
partner under the partnership agreement does not
have substantial economic effect. Final regulations
clarify the meaning of substantial economic effect (T.D.
9398, 5/16/08, corrected 6/11/08). Generally, the
economic effect of an allocation is substantial if there
is a reasonable possibility that the allocation will affect substantially the dollar amounts to be received
by the partners from the partnership, independent
of tax consequences (Reg. §1.704-1(b)(2)(iii)). If the
partnership agreement provides for an allocation of income, gain, loss, deduction or credit that does not have
economic effect, then the allocation is made according
to the partner’s interest in the partnership. Proposed
regulations determine distributive share when the
partner’s interest varies during the partnership’s tax
year (“varying interest rule”) (NPRM REG-14468904, 4/14/09).
Even if the distributive share is held by a partner in
escrow pending a lawsuit while the proper allocation
among partners was worked out, it must still to be
1065 prep_10_book.indb 60
taken into income; the rule requiring recognition
of the distributive share takes precedence over the
rule regarding claim of right (Burke, CA-1, 2007-1
USTC ¶50,497).
If the partnership agreement does not express the partners’ share of profit, loss, and capital, then the partnership
can use any reasonable method to arrive at percentages
as long as the method is consistent with the partnership
agreement and is applied consistently from year to year.
The IRS has provided the following example:
Partners A and B are partners in Partnership AB. At the
beginning of 2009, Partner A and Partner B had capital
account balances of $2,000 and $667, respectively. The
AB Partnership Agreement requires capital accounts to
be maintained in accordance with Section 704(b). The
partnership agreement does not express the partners’
shares of profit, loss, and capital as fixed percentages.
In 2009, Partnership AB adopts the fol-lowing method
for determining the percentages of capital, profit, and
loss to be used in completing Schedule K-1, item J and
Schedule B, questions 3 and 4.
Partnership AB computes the partners’ end of tax year
percentages of capital by dividing each partner’s positive
capital account balance on the last day of the partnership’s tax year by the total positive capital ac-count
balances on the last day of the partnership’s tax year
and expressing the result as a percentage. Part-nership
AB reports a negative capital account balance as a zero
percentage. Partnership AB reports the prior end of tax
year percentages of capital as the beginning of tax year
percentages of capital.
Partnership AB computes the partners’ percentages of
profit for the tax year as each partner’s share of items
which increased partnership capital during the tax year,
other than contributions to capital. Partnership AB computes the partners’ percentages of loss for the tax year as
each partner’s share of items which decreased partnership
capital during the tax year, other than distributions.
The Partnership Agreement allocates Section 704(b)
profits and losses for the tax year as follows: 1) first to
Partner A as a preferred return on capital equal to 5%
of Partner A’s beginning capital balance, 2) then 80%
to Partner A and 20% to Partner B until Partner A is allocated profits equal to an aggregate10% preferred return
on Partner A’s beginning capital balance. Any residual
profits or losses are allocated 60% to Partner A and 40%
to Partner B. Allocations of taxable income or loss follow the Section 704(b) allocations, and Partnership AB
uses the section 704(c) traditional method to account
11/6/2009 3:30:18 PM
MODULE 2 — CHAPTER 7 — Schedule K-1
for any differences between Section 704(b) profits and
losses and tax profits and losses.
For the tax year ended December 31, 2009, Partnership
AB generated $1,000 of Section 704(b) profits and $900
in taxable income. In accordance with the AB partnership agreement, Partner A is allocated $665 of Section
704(b) profits as follows: 1) $100 of the first $100 of
profits to equal a 5% preferred return on Part-ner A’s
beginning capital, 2) an additional $100 of the next $125
of profits equal an aggregate 10% pre-ferred return on
Partner A’s beginning capital, and 3) $465 of the remaining $775 in profits, which is equal to 60% of Partnership
AB’s residual profits. Partnership AB allocates all tax
items to follow the section 704(b) allocations, with the
exception of a $100 capital loss which was solely allocated
to Partner A under Section 704(c).
Partnership AB
A
Beginning Capital
$2,000
Preferred Return
200
Residual Profit
465
Amount Allocated to B
B
Total
$ 667
$2,667
200
465
335
335
$3.667
End of Year Capital
$2,665
$1,002
Percentage of Capital
72.68%
27.32%
Profits percentages. Partner A’s percentage share of partnership profits for the tax year is 66.5% [$665 di-vided by
$1,000]. Partner B’s percentage share of profits for the tax
year is 33.5% [$335 divided by $1,000].
Loss percentages. Partner A’s percentage share of part-
nership losses for the year is 0.0%. Even though a $100 loss
was allocated to Partner A under section 704(c), this loss
did not impact his section 704(b) capital account. Thus,
because he was allocated no losses that would impact
capital accounts, his percentage share is zero. Likewise,
Partner B was allocated no losses that would impact his
Section 704(b) capital account and Partner B’s percentage
share of partnership losses for the year is 0.0%. If Partnership AB had a net loss for the year for the Section 704(b)
capital accounts, Partner A’s percentage share of the net loss
would be 60% and Partner B’s percentage share of the net
loss would be 40% under the agreement and the reasonable method adopted for Item J. In such case, Partner A’s
percentage share of profit would be 0.0% and Partner B’s
percentage share of profit would also be 0.0%.
Capital percentages. Partner A’s share of total Section
704(b) capital at the end of the tax year is $2,665 [$2,000
plus $665]. Partner A’s share of capital computed as a
percentage of total partnership Section 704(b) capital is
1065 prep_10_book.indb 61
61
72.68% [$2,665 divided by $3,667]. Partner B’s share
of total Section 704(b) capital at the end of the tax year
is $1,002 [$667 plus $335]. Partner B’s share of capital
computed as a percentage of to-tal partnership Section
704(b) capital is 27.32 % [$1,002 divided by $3,667].
Special allocations. A partnership agreement may
provide for special allocations of certain partnership
items. These are allocations of gain, income, loss,
deductions, or credits that are disproportionate to
a partner’s capital contributions. For example, some
agreements might allocate all of the depreciation to
one partner. However, special allocations are permitted only if they have substantial economic effect
(Code Sec. 704(b)).
There is substantial economic effect if there is an economic
benefit or burden to the allocation, and it must actually
affect the dollar amount received by a partner. In other
words, the allocation must be reflected in adjustments to
the partner’s capital account, and in the amount receivable upon liquidation.
The economic effect must be substantial in comparison with the tax consequences. For example, a special
allocation may be disregarded if it is reversed in a
subsequent taxable year. The IRS will not issue an
advance ruling on whether an allocation in a particular partnership agreement has substantial economic
effect. If the IRS questions the allocation and it does
not stand up as having substantial economic effect,
then the allocation will be made in accordance with
the partner’s partnership interest (see Reg. §1.704-1(b)(3)(i)-(iii)).
Regulations detail the making of allocations with respect
to contributed property (Reg. §1.704-3).
PRACTICE POINTER: A partnership return should
not be prepared without reading the portions of the
partnership agreement dealing with the distributive
shares and capital accounts.
A partnership can exist without a formal partnership
agreement. If this is the case, the distributive share is
simply the partner’s proportionate interest in the partnership. For example, a partner had to include her distributive share in income even though there was no actual
distribution and no partnership agreement setting forth
her distributive share In this case, her distributive share
was simply her proportionate interest in the partnership.
(Brooks, TC Memo 1995-400).
11/6/2009 3:30:19 PM
62
1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
PRACTICE POINTER: In the absence of a written
partnership agreement, or if the determination depends upon an interpretation of the agreement, obtain written instructions from the managing partner as
to the manner in which allocations are to be made.
In making allocations, it’s important to keep in mind
that items passed through retain the same character in
the hands of the distributee-partner as in the hands of
the partnership.
STUDY QUESTION
Special allocations are required for built-in gains and
losses. They are also required for purposes of depreciation
and depletion on property contributed after March 31,
1984 (Code Sec. 704(c)).
2.
With respect to special allocations, which of the
following statements is correct?
a. Special allocations are always permitted.
b. Special allocations are permitted only if they
have substantial economic effect.
EXAMPLE: On July 1, Adams $10,000 contributed to
a 50/50 partnership, while Bradley contributed land
with a basis of $2,500, but valued at $10,000. The
pre-contribution appreciation of $7,500 must be allocated to Bradley. This will prevent Adams from having
to recognize any pre-contribution appreciation (i.e.,
Adams paying tax on gain arising during Bradley’s
sole ownership of the land prior to contribution).
Conversely, if the land is sold at a price less than
its contribution value, but for more than its $2,500
basis, Adams will not be able to claim a loss. The
gain on the land, if any, would be allocated to Bradley. Had the contribution consisted of depreciable
property, the allocation of depreciation would have
to take into account the difference between basis
and contribution value.
PRACTICE POINTER: The partnership can eliminate
ceiling rule distortions by making remedial allocations
of income, gain, loss, etc., to noncontributing partners (Reg. §§1.704-1 and 1.704-3). Check whether
such allocations are advisable.
A partner joining in mid-year receives only an allocable
portion of gains and losses. No retroactive allocations
are permitted. Allocations are made on a daily basis or
on some other segment of time. If the partnership is
on the cash basis, it must allocate any interest expense,
taxes, and payment for services or use of property on a
daily basis (Code Sec. 706(d)).
When a partner’s profit and loss ratio is modified during the
partnership’s year to reflect additional cash contributions by
him or her or by other partners, the year-end profit or loss
may be allocated to the partner based on any reasonable
method that takes into account the varying interests of the
partner during the year (“varying interest rule”). (Proposed
regulations, NPRM REG-144689004, 4/14/09).
In the case of tiered partnerships, daily allocations are
required for items passing from a subsidiary partnership
to a parent partnership.
1065 prep_10_book.indb 62
c. Special allocations are never permitted.
ADMINISTRATIVE ASPECTS OF SCHEDULE K-1
A Schedule K-1 is required for each person who was a
partner at any time during the year. If the partnership
has 50 partners throughout the year, then there must be
50 Schedule K-1s attached to the partnership return.
PRACTICE POINTER: If payments are being made to
retired partners, the payees are treated as partners.
Schedule K-1 must be provided to the partner on or
before the day on which the partnership return is filed.
Thus, if the partnership is on a calendar year and the
return is filed on April 15th, the partner must also get
Schedule K-1 by April 15th. As a practical matter, K-1s
must be submitted to the partners before April 15, to give
them time to file their own tax returns. If the partnership files Form 7004 to request additional time to file
its 2009 tax return, then the return and the distribution
of al K-1s is extended for five months.
Separate Schedule K-1s are required if a husband and wife
each had a partnership interest. However, only one schedule
is required if the partnership interest is held jointly by the
couple—such as joint tenants with rights of survivorship.
If a partnership interest is held by a nominee, then the
Schedule K-1 is furnished to that nominee.
There are penalties for any failure to furnish a Schedule
K-1. The amount of the penalty is $50 per failure, up to
a maximum of $100,000 for all such failures during a
calendar year. If the failure is intentional, the penalty is
increased to the greater of $100 or 10% of the aggregated
items required to be reported. There is no dollar limit on
this penalty.
The IRS has identified the following common problems encountered when filling out the Schedule K-1
11/6/2009 3:30:19 PM
MODULE 2 — CHAPTER 7 — Schedule K-1
(IR-2007-42, 2/27/07). To ensure that these problems
do not exist, the following steps should be taken.
Ensure that the proper taxpayer identification numbers are used on Schedule K-1
Identify amended Schedule K-1s
Report income in the proper location on individual
returns as indicated on Schedule K-1
Avoid netting or combining income against losses
or expenses. For example, unreimbursed partnership
expenses from nonpassive activities should be entered
on a partner’s return on a separate line in column (h) of
Schedule E’s line 28 and labeled “UPE” in column (a)
of the same line—do not combine these expenses or net
them against any other amounts from the partnership.
Report deductible at risk or basis limitation losses
carried forward from prior years on a separate line
from current year transactions
Identify estimated K-1 income
Report elections properly
PART I: INFORMATION ABOUT THE
PARTNERSHIP (LINES A-D)
On lines A–D of Schedule K-1, fill in the partnership’s
employer identification number, its name and address
and the IRS center where the partnership return is filed.
Check the box to indicate whether the partnership is a
publicly-traded partnership (PTP).
PART II: INFORMATION ABOUT
THE PARTNER (LINES E-L)
On lines E-L, enter general information about the
partner. The partner’s identifying number (line E) and
contact information (line F) are provided. On line G,
indicate whether the partner is a general partner or
LLC member-manager; or a limited partner or other
LLC member. On line H, indicate whether the partner
is a domestic partner or foreign partner. Line I lets the
IRS know what type of entity the partner is, such as a
corporation, estate, individual, etc.
J. Partner’s Share of Profit, Loss and Capital. Report
on line J the partner’s share of profit, loss and capital at
the beginning and end of the year (as a percentage of
the partnership’s profit, loss and capital.
PRACTICE POINTER: New instructions to Item J of
Schedule K-1 clarify how a partnership determines
the partners’ percentage share in the profit, loss,
and capital at the beginning and end of the partnership’s tax year.
1065 prep_10_book.indb 63
63
Report
on this line the partner’s share of nonrecourse, qualified nonrecourse financing (Code Sec. 465(b)(6)), and
recourse liabilities at the end of the year.
K. Partner’s Share of Liabilities at Year End.
Provide the
partner’s capital account analysis on line L.The purpose
of supplying an analysis of the partner’s capital account
is to permit the IRS to ensure that losses claimed by the
partners do not exceed allowable limits.
L. Partner’s Capital Account Analysis.
The IRS has ruled that a partnership may allocate builtin gain or loss from the revaluation of the Code Section
197 intangible triggered by the entry of a new partner
(Rev. Rul. 2004-49, 2004-1 CB 939).
EXAMPLE: The AB partnership takes in a new partner, C, who contributes cash to the partnership in
exchange for a partnership interest. The partnership
revalues its assets, including a Sec. 197 intangible
that was being amortized.
The partnership may make traditional, curative or
remedial allocations of amortization to take into account the built-in gain or loss from the revaluation
of the intangible asset.
Partnerships can book-up partners’ capital accounts to
reflect current market values when a partner is granted
an interest in the partnership in exchange for services
performed (T.D. 9126, 5/5/04). The services must be
performed for the benefit of the partnership by an existing partner acting in a partnership capacity, or by a new
partner acting in a partnership capacity or in anticipation
of becoming a partner.
On Schedule K-1, the partnership informs the partner
his or her capital account at the beginning of the year,
capital contributions during the year, and other increases
and decreases to the capital account. These other increases and decreases include certain adjustments for net
income per books, as figured on Schedule M-2, and for
withdrawals and distributions.
The capital account for the end of the year is then reported
on Schedule K-1. The totals of the beginning and ending
capital accounts shown on the Schedules K-1 for all the
partners should agree with Line 21 of Schedule L.
PRACTICE POINTER: If the partnership answered
“yes” to question 6 of Schedule B and was not required to complete Schedules L, M-1 and M-2, then
it will not have to complete line L of Schedule K-1.
11/6/2009 3:30:19 PM
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At the top of Schedule K-1, indicate whether the form
is a final K-1 or an amended K-1.
M. Contribution of property with built-in gain or
loss. Check yes or no to indicate whether there was a
contribution of property by the partner with a build-in
gain or loss. If yes, attach a statement explaining the
contribution.
Domestic Production Activities
Deduction
Domestic Production Activities
Partner’s Share of Qualified
Production Activities
Partner’s Share of Form W-2 Wages
(a limitation on the domestic
production activities deduction) *
Form
Box #
K-1
K-1
13
13
Code
T
U
K-1
13
V
PART III: PARTNER’S SHARE OF CURRENT
YEAR INCOME, DEDUCTIONS, CREDITS, AND
OTHER ITEMS (LINES 1-19)
* W-2 wages include only those amounts allocated to domestic
production gross receipts (DPGR). The IRS has provided
guidance on pass-through entity level calculations, such DPGR
and W-2 wages, for the domestic production activities deduction,
and how QPAI and W-2 wages are allocated to partners (Rev.
Proc. 2007-34, IRB 2007-23, 1345).
Usually, the distributive share is the ordinary income
or loss of the partnership, regardless of whether it has
been distributed or whether the partnership agreement
requires it to be contributed to capital. The allocated
income or loss is then picked up by the individual partners, regardless of actual distributions.
A partnership engaged in the extraction and processing of
minerals within the U.S. is a qualifying in-kind partnership for purposes of the domestic production activities
deduction—each partner is treated as having extracted
property that is extracted by the partnership (Rev. Rul.
2007-30, IRB 2007-21, 1277).
However, guaranteed payments (line 4) for salary to
partners who work for the partnership, and for interest
on capital, need to reflect the actual payments to the
partners. Schedule K-1 is not always a simple allocation
of Schedule K. There are a number of differences and
refinements, such as special allocations to a partner.
EXAMPLE: Adams and Bradley are equal partners
in an accrual basis partnership that makes a total of
$100,000 in income in its tax year.
The terms of the partnership agreement require
each partner to leave one-half of his earnings in the
partnership as a contribution to capital.
Each partner’s distributive share of profit is still
$50,000. This is so even though the partners are
permitted to take out only $25,000 each. The difference between each partner’s allocated share of
income and his distributions gets added to his basis
in the partnership.
PRACTICE POINTER: Page 2 of Schedule K-1
provides a list of codes used on Schedule K-1 and
summarizes the information provided to partners. It
also includes guidance on where partners report the
information on their personal returns.
For example, if Code A is entered on line 14 for selfemployment earnings, the code directs the partner to
enter this amount on Schedule SE (Form 1040).
Follow the instructions to Schedule K-1 on where to report certain items used to figure the domestic production
activities deduction on a partner’s individual return.
1065 prep_10_book.indb 64
PART III: PASSIVE ACTIVITY LOSS RULES
(LINES 1-3)
If losses are reported for trade or business activities or
rental real estate, the passive activity loss (PAL) rules
come into play for the partners (Code Sec. 469). Limited
partners automatically are treated as passive investors for
purposes of the passive activity loss rules.
Courts have held that limited liability company members
are not treated like limited partners for purposes of the
PAL rules and may materially participate in an activity so
as to escape the PAL limitations (Garnett, 132 T.C. No.
19 (2009) and Thompson, Ct. Fed. Cl., 2009-2 USTC
¶50,501). The reason: LLC members by definition can
participate in the operations of the entity, while limited
partners cannot.
PART III: OTHER INFORMATION (LINE 20)
The partnership can provide an additional explanation on
line 20 of Schedule K-1 or attach a separate schedule if there
are any deviations from a straight allocation. Also use line 20
of Schedule K-1 to explain items on line 20c of Schedule K
(the catchall line for reporting various items and information
not covered elsewhere that an individual partner would need
to know in order to complete his or her return).
If the partnership has more than one trade or business
activity, or more than one rental real estate activity, attach
a statement to explain.
The first-year expense deduction should not be entered
on Schedule K-1 if the partner is a trust or estate, since
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MODULE 2 — CHAPTER 7 — Schedule K-1
these entities are not entitled to claim a first-year expense
deduction. Furthermore, if the partnership has prematurely disposed of property for which a first-year expense
deduction could have been claimed, the partnership must
notify the partners so that they can recapture any first-year
expense deduction. This recapture should be explained on
line 20 of Schedule K-1.
If the partnership has a defined benefit plan, provide the
amount of the partner’s accrued benefit on Schedule K-1
on line 20.
STUDY QUESTIONS
3.
With respect to furnishing Schedule K-1, which
statement is not correct?
a. If the partnership interest is held by a nomi-
nee, the Schedule K-1 must be furnished to
the nominee.
b. The Schedule K-1 must be furnished to each
person who had an interest in the partnership
at any time during the year.
c. The Schedule K-1 must be furnished only to
the person who has an interest in the partnership on the last day of the year.
4.
In providing an analysis of a partner’s capital account on line N of Schedule K-1, a partnership can
book-up the account to reflect market values when
the partner is granted an interest in the partnership in
exchange for services performed. True or False?
CONTRIBUTING PROPERTY
TO THE PARTNERSHIP
A partner contributing property does not realize gain or
loss. The partner’s basis for his or her partnership interest is increased by the partner’s basis of in the property
contributed. The partnership takes over the partner’s
basis in the property. The contribution of built-in gain
or loss is indicated on line M of Schedule K-1.
EXAMPLE: Adams, one of two equal partners, con-
tributes $20,000 cash. Bradley, the other partner,
contributes unimproved real property worth $20,000,
but originally costing $10,000, Bradley’s basis in the
partnership of $10,000. The partnership’s basis in the
property is $10,000—Bradley’s basis in that property
prior to contribution.
PRACTICE POINTER: While a partner does not rec-
ognize gain or loss on the contribution of property to
a partnership, gain or loss may have to be recognized
if the property is distributed to non-contributing partners within seven years of the contribution.
1065 prep_10_book.indb 65
65
Regulations describe the tax treatment of installment
obligations and contracts for the acquisition of property
contributed to a partnership (T.D. 9398, 5/16/08, corrected 6/11/08). Specifically, if the installment obligation
or property acquired pursuant to a contributed contract
is distributed by the partnership to a partner other than
the contributing partner within seven years of the contribution, the contributing partner must recognize gain
or loss under Code Section 704(c)(1)(B).
STUDY QUESTION
5.
A partner contributes unimproved land to the partnership. The partner’s adjusted basis in the land
is $10,000; its value at the time of contribution is
$15,000. By making this contribution, the partner can
increase the basis in his partnership interest by:
a. $10,000
b. $15,000
c. Neither of the above—the partner may not
increase basis
SELLING PROPERTY TO THE PARTNERSHIP
A partner can sell property to the partnership. From the partnership perspective, nothing is reported on Form 1065. The
partner recognizes gain, but the partnership then receives a
stepped-up basis in the property. The selling partner may, in
certain instances, defer taxation by making an installment
sale. If the property is subject to depreciation recapture by
the partner, there is immediate income upon the sale notwithstanding the installment sale arrangement.
If the selling partner has a more-than-50% interest in the
partnership, his gain will be taxed as ordinary income if
the property is a depreciable property in the hands of the
partnership (Code Sec. 1239). In determining ownership
interests, broad attribution provisions are applied (see
Code Sec. 1239(b) for more on this topic).
If the sale results in a loss to a partner who has a morethan-50% interest, the loss will be disallowed, although
it may be utilized to reduce any realized gain on a subsequent sale by the partnership (Code Sec. 707(b)).
PRACTICE POINTER: The best rule of thumb to follow
for loss property is not to sell it to the partnership.
BASIS
A partner’s basis in a partnership interest is important for
a couple of reasons. When a partner sells his or her interest, that partner needs to know basis to determine gain
or loss. The partner also needs to know the partnership’s
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
basis, because losses from the partnership may not exceed
the partner’s basis in that interest. Losses in excess of basis
can be carried forward to subsequent years.
PRACTICE POINTER: There is no time limit on the
carryforward of partnership losses in excess of
partnership basis.
PITFALL: Where a partnership interest changes
hands, or where special allocations are in effect, the
capital accounts may not reflect basis.
Increases in basis. Basis in a partner’s interest in the
partnership is increased by:
Partner’s distributive share of partnership income
Partner’s share of the partnership’s tax-exempt income
(such as life insurance proceeds)
Excess of depletion deductions over the basis of depletable property
Additional capital contributions
An increase in the partner’s share of partnership liabilities
(see below)
EXAMPLE: A short sale by a partnership resulted
Losses are further limited by the at-risk loss rules (Code
Sec. 465) and the passive activity rules (Code Sec. 469).
In general, losses cannot exceed amounts that the partner
has at risk in the activity.
Losses from the activity are subject to the passive loss rules.
For partners who regularly participate in the business,
this poses no problem. However, for partners who do not
materially participate in the business, losses are treated as
passive losses. Limited partners generally must devote at
least 500 hours to an activity during the year in order to
be considered as material participants. It is unclear whether
LLC members should be treated as limited partners, so
they must maintain a similar level of involvement.
Remember, too, that an exception applies to the passive
loss rules for real estate professionals (those who meet
certain levels of participation in certain real estate activities). Because of the at-risk and passive activity loss rules,
Schedule K breaks out income, expenses, and credits related to rental real estate. This enables non-participating
partners to determine their own passive activity loss
deductions and credits on their individual returns.
A partner can acquire an interest in one of several ways:
A contribution to the partnership at the time the
partnership is formed.
Purchase of an interest from an outgoing partner.
Gift or inheritance of an interest. If a partner acquires
interest by making a contribution to the partnership,
then the partner’s original basis is equal, generally, to
the basis of that partner’s contribution to the partnership. Basis includes cash and the basis of other
property contributed. Any increase in a partner’s share
of the liabilities of a partnership, or any increase in
a partner’s individual liabilities by reason of the assumption by such partner of partnership liabilities, is
considered as a contribution of cash by such partner
to the partnership (Code Sec. 752 (a)).
1065 prep_10_book.indb 66
in partnership liability, which, in turn, increased the
partners’ bases (Rev. Rul. 95-26, 1995-1 CB 131).
Presumably the amount of the liability is the amount
of cash received in the short sale.
Partners in a cash-basis partnership may not increase
basis by accrued partnership liabilities, such as interest expenses and accounts payable (Rev. Rul. 88-77,
1988-2 CB 128).
Decreases in basis. Basis in a partner’s interest in the
partnership is decreased, but not below zero, by the:
Partner’s distributive share of partnership losses,
including capital losses
Partner’s share of partnership expenses that is not deductible in computing partnership income. However,
a partner can never have a negative basis.
Distributions
A decrease in the partner’s share of partnership liabilities.
If the decrease in liabilities exceeds the partner’s basis, gain
will result. The determination is made at year-end.
STUDY QUESTIONS
6.
A partner must reduce the basis in his or her
partnership interest by:
a. The partner’s distributive share of capital losses
b. The partner’s share of partnership expenses
that are not deductible in computing partnership income
c. Both a. and b.
7.
A partner’s basis in his partnership interest can
never be a negative number. True or False?
LIABILITIES (“LIABILITIES UP—MONEY IN.
LIABILITIES DOWN—MONEY OUT.”)
When property transferred to a partnership is subject
to liabilities, keep this special rule in mind: “Liabilities
up—money in. Liabilities down—money out.”
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MODULE 2 — CHAPTER 7 — Schedule K-1
What this means is that if there is an increase in a partner’s
share of partnership liabilities or an assumption by the
partner of partnership liabilities, then it is treated as a
money contribution by that partner and there is a like
increase in his or her basis.
If there is a reduction in the partner’s share of partnership
liabilities or an assumption by the partnership of his or
her liabilities, this is treated as a distribution of money
by the partnership to the partner, and the partner’s basis
is reduced accordingly.
Final regulations define partnership liabilities under
Code Section 752 (T.D. 9207, 5/23/05). The regulations
prevent taxpayers from creating artificial losses when a
partnership assumes a partner’s liability.
There are two types of liabilities:
1. Reg. §1.752-1 liabilities
2. Reg. §1.752-7 liabilities
The first type (§1.752-1), which includes mortgages,
is a partnership liability to the extent that it creates or
increases the basis of any of the obligor’s assets, including
cash, gives rise to an immediate deduction for the obligor, or gives rise to an expense that is not deductible in
figuring taxable income but is properly chargeable to the
capital account. This type of liability requires partners
to immediately reduce their basis in their partnership
interests when such liability is transferred by a partner
and assumed by the partnership.
The second type (§1.752-7) includes all other liabilities—including contingent liabilities and derivatives
such as options. The transfer of this type of liability does
not result in immediate basis reduction.
Instead, basis is reduced when there is a separation event,
which includes the disposition or partial disposition of the
partnership interest, a liquidation of the partnership interest, or the assumption of liability by another partner. There
is, however, a de minimis exception for liabilities assumed
liabilities that are less than $10 million or 10 percent of
the gross value of partnership assets, whichever is less.
A payment obligation of a disregarded entity for which
a partner is treated as bearing the economic risk of loss
is taken into account only to the extent of the net value
of the disregarded entity (called the net value approach),
for liabilities incurred or assumed by a partnership on
or after October 11, 2006 (T.D. 9289, 10/10/06). A
disregarded entity includes a one-member LLC, a qualified Subchapter S (QSub) subsidiary and qualified real
estate investment trust (REIT) subsidiary.
1065 prep_10_book.indb 67
67
ACQUIRING A PARTNERSHIP INTEREST
IN EXCHANGE FOR SERVICES
In general, if a capital interest in a partnership is acquired
in exchange for services in the formation of the partnership,
the partner recognizes ordinary income (Reg. §1.721-1(b)
(1)). The value of a profit interest received for services was
taxable where its value was readily determinable. (Diamond, CA-7, 74-1 USTC ¶9306) and the value of a capital
interest received for services was taxable (Mark IV Pictures, Inc., CA-8, 92-2 USTC ¶50,365). However, where
the value of the interest was speculative, the contribution
of services in exchange for a profit interest was not taxable
(Campbell, CA-8, 91-1 USTC ¶50,420).
Proposed regulations address the tax consequences of
contributing services to a partnership in exchange for a
partnership interest (Notice 2005-43, IRB 2005-24, 1221;
NPRM REG-105346-03, 5/23/05; Treasury Department
News Release JS-2461, 5/20/05). Under the proposed
regulations, an interest—both a profits and a capital
interest—acquired through the performance of services
is treated as property subject to Code Section 83.
The person who becomes a partner through the performance of services is called a service provider. The value of
the interest acquired by a service provider is its fair market
value at the time of the transfer. The partnership may elect
to value the partnership interest as equal to its liquidation
value. This is the amount of cash that the holder of the
partnership interest would receive if the partnership were
liquidated. The partnership, partners, and service provider
must all agree to use this valuation. The service provider is
treated as a partner as of the date the interest is substantially
vested, which means it is no longer subject to a substantial
risk of forfeiture. If the person is not substantially vested,
he or she can make a Section 83(b) election to be treated
as substantially vested. Making the election requires the
service provider to report the receipt of the partnership
interest as income. The service provider’s capital account
is increased by the amount included in income as compensation, including any interest. Generally this is the fair
market value of the interest, but it can be the liquidation
value if the election discussed earlier is made.
For purposes of Schedule K-1 reporting, under proposed
regulations issued in 2005, partnership interests transferred in exchange for services are treated as guaranteed
payments by the partnership.
In 1993 the IRS had ruled that a partner receiving a
profit interest in exchange for services is not taxable if all
of the following conditions are met (Rev. Proc. 93-27,
1993-2 CB 343):
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
Services to or for the benefit of the partnership are
done to become a partner.
The partnership interest is a future profits interest
other than a substantially certain and predictable
stream of income from partnership assets.
The partnership is not a publicly-traded partnership.
The interest is not sold by the service partner within
two years.
There is no readily determinable value.
PRACTICE POINTER: The amount of such ordinary
income reported as a result of receiving a partnership
interest for services rendered becomes the partner’s
basis in the partnership interest.
If a partnership interest is purchased from an outgoing
partner, the incoming partner takes as his or her basis the
cost of the purchase. If a partnership interest is inherited,
then the basis for the partner-heir is the fair market value
of that interest for estate tax purposes.
Recourse liabilities are generally allocated to the partner or partners who bear the economic risk of loss. For
example, in one case, all of a limited liability company’s
recourse liability was allocated to the individual member
who personally guaranteed the loan because he was the
only party who bore the risk of loss in case the partnership was liquidated (IPO II, 122 TC 295 (2004)).
Special rules apply to the allocation of nonrecourse liabilities. The regulations provide some flexibility (Reg.
§§1.752-3 and 1.752-5).
Generally, nonrecourse liabilities are allocated among
partners on the basis of a three-tiered structure. However,
the regulations allow a partnership to allocate the portion
of nonrecourse liabilities in excess of the portion allocated
in tiers one and two (excess nonrecourse liabilities) based on
the excess of gain under Code Section 704(c) attributable
to the property securing the basis. The result: This excess
portion can be allocated to the partner contributing the
property based on the gain inherent in that property.
Nonrecourse liability is allocated among LLC members,
based on how they share a class of entity income or gain,
rather than a gross income allocation within a class of
income (TAM 200436011).
If no partner has liability, as would be the case with most
mortgages on real property, then all partners share in the
partnership liabilities.
In the case of an LLC, since no member bears the
economic risk of loss beyond the amount of his or
1065 prep_10_book.indb 68
her contribution, all LLC debt should be treated as
nonrecourse for the purpose of tax basis. There are
four exceptions:
1. When a member of an LLC (or a person related to such
member) guarantees or makes a loan to the LLC.
2. When state law imposes the obligation on a member.
3. When the debt falls within the interest guarantee
rule (Reg. §1.752-2(e)) or the property pledge rule
(Reg. §1.752-2(h)).
4. When the anti-abuse rule applies (Reg. §1.752-2(j)).
Accrued expenses that are not immediately deductible
by the partnership may not be treated as liabilities and
so such expenses do not increase a partner’s basis in a
cash basis partnership. However, capitalized items, such
as organizational expenses and construction period interest and taxes that increase the basis of partnership assets,
may be treated as liabilities for purposes of determining
the partner’s basis in the partnership interest.
A reduction in a partner’s share of liabilities is treated as
an advance or draw of funds to the extent of the partner’s
distributive share of income for the partnership year (drawing year) (Reg. §1.731-1(a)(1)(ii)), so that such amounts are
taken into account at the end of the year rather than at the
time of distribution (Rev. Rul. 94-4, 1994-1 CB 196).
PITFALL: Although a partner’s capital account can
be negative, basis can never be negative.
If there was a distribution of property or a transfer of a
partnership interest during the tax year, the partnership
can elect to adjust the basis of partnership assets (Code
Sec. 754) (see Chapter 2). More specifically, the partnership can adjust the basis of undistributed partnership
assets when assets distributed to a partner have increased
or decreased in value. It can also adjust the basis of its
assets to reflect the purchase price paid by a new partner
for his or her partnership interest. But since this latter
adjustment is made with respect to the transferee partner
only, it is rarely done on the partnership books.
Regulations prevent corporate partners from adjusting
the basis of their partnership interests where there is no
economic offset (Reg. §1.705-2 and Reg. §1.705-1). An
increase or decrease in a corporate partner’s adjusted basis,
resulting from the sale of corporate stock, equals the gain
or loss that the corporate partner would have recognized
if an election under Code Section 754 had been in effect.
Recognition is made without the application of Code
Section 1032 (that otherwise allows nonrecognition of
gain to a corporation on the exchange of its stock).
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8
MODULE 2 — SCHEDULES AND FORM COMPLETION
Completing the Return
LEARNING OBJECTIVES
This chapter discusses how to finish Form 1065 for filing.
It also describes the consolidated audit procedures.
Upon completion, you will be able to:
Identify the tax matters partner
Explain the rules for IRS audits of partnership returns
OVERVIEW OF FORM COMPLETION
After completing all required forms and schedules, it
is time to assemble the return and prepare it for filing.
This includes designating a tax matters partner (TMP)
and deciding who needs to sign the return.
DESIGNATION OF TAX MATTERS PARTNER
The tax matters partner (TMP) is the person who is
named by the partnership to represent it before the IRS.
Details on the TMP are discussed later in this chapter.
On the bottom of page 3 of Form 1065, enter the name,
address, and identifying number of the TMP.
PREPARER INFORMATION
A preparer must sign the return and include the firm’s
name (or the preparer’s name if self-employed), address,
telephone number and if self-employed, the employer
identification number (EIN) (or Social Security number
or preparer tax identification number (PTIN)).
SIGNING THE RETURN
The partnership return must be signed by a general
partner of a partnership, or a member of an LLC taxed
as a partnership. This person does not need to be the
same as the TMP.
The partnership may authorize the preparer to discuss
administrative matters, such as omission of a required
schedule or an unclear entry on the return with the IRS.
If so, check the box next to the signature line.
1065 prep_10_book.indb 69
STUDY QUESTION
1.
Form 1065 can be signed by:
a. Any general partner
b. Only the Tax Matters Partner (TMP)
c. Any partner, whether a general partner or a
limited partner
NOTE: Answers to Study Questions, with feedback
to both the correct and incorrect responses, are provided in a special section beginning on page 85.
AUDITS: PARTNERSHIP
INFORMATION TAX RETURN
While a partnership does not pay federal income tax, it
is required to file an annual partnership information tax
return. Unless a partnership falls within the “small partnership” exception, the partnership will be assessed a penalty at
the partnership level for a failure to file or timely file Form
1065 by the due date of the return, generally the 15th
day of the fourth month. A five-month extension may be
obtained by filing Form 7004 no later than the original
due date for Form 1065. The statute of limitations for all
income tax assessments must be made within three years
after the date the tax return is filed or the original due date
of the tax return, if later. In the case of pass-through entities,
such as a partnership, the three-year rule begins to run at
the time the partner files his individual income tax return
or the original due date of the tax return, if later (Code Sec.
6229(a)). The statute of limitations can be extended to six
years if there is an omission of more than 25% of income.
An overstatement of basis is not considered an omission of
income that could extend the statute of limitations (Salman
Ranch Ltd., CA-FC, 2009-2 USTC ¶50,528; Bakersfield
Energy Parters, LP, CA-9, 2009-1 USTC ¶50,448; Beard,
TC Memo 2009-184). Whether properly reporting offsetting options as a net loss constitutes an omission of income
depends on the circumstances (Highwood Partners, 133
TC No. 1 (2009)).
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
In general, partners must report their income consistent
with the partnership return (they pick up their income
from Schedule K-1 prepared by the partnership). But
sometimes a partner may disagree with the way in which
the partnership handled a particular item.
The partner may want to report an item in an inconsistent manner. If the partner does this, he or she must
note such inconsistent treatment. Form 8082, Notice
of Inconsistent Treatment or Amended Return, is used to
report inconsistent treatment.
PITFALL: If a Section 754 election is in effect, basis
adjustments under Section 743 frequently require
such reconciliation. If the inconsistent treatment is
not reported, then the IRS can conform the partner’s
return to the partnership’s reporting and assess additional taxes without notification to the partner or
commencement of a partnership proceeding (Temp.
Reg. §301.6222(b)-2T(b)).
PITFALL: Again, the IRS has a computer-matching
program to cross-check entries on partners’ personal returns with amounts reported to them on
Schedule K-1.
Consolidated audit procedures. In general, audits are
conducted at the partnership level (Code Secs. 6221
through 6233). This means that the treatment of a particular item is determined by auditing the partnership
rather than auditing each partner. This partnership level
audit is referred to as the consolidated audit procedures.
It applies to the audit of partnership items such as income,
gain, loss, deductions, and credits from the partnership. It does not apply to nonpartnership items, such as
determining a partner’s at-risk amount. The identity of
the partners is not a partnership item (Alpha I, LP, Fed.
Cl., 2009-1 USTC ¶50,267).
EXAMPLE: The issuance of a deficiency notice to
a limited partner regarding liability for penalties for
non-partnership items did not confer jurisdiction on
the Tax Court to re-determine the underlying deficiency attributable to partnership items (Bradley,
100 TC 367 (1993)).
Also, a partner who made a refund claim on an
amended return, Form 1040X, could not bring his
case before a court because an administrative
adjustment request should have been filed instead
(Rothstein, Fed. Cl., 98-1 USTC ¶50,435).
1065 prep_10_book.indb 70
An audit of a partner with respect to tax shelter losses of
a limited liability company (taxed as a partnership) is not
premature where the IRS has no intention of auditing the
partnership; Tax Court has jurisdiction where affected
items can be addressed at the partner-level (Meruelo,
132 TC No. 18 (2009)).
Small partnerships are exempt from such audits (Prop.
Reg. §301.6231(a)(1)-1). Instead, the IRS will audit the
individual partners with respect to partnership items.
Small partnerships are those consisting of 10 or fewer
partners, each of whom is a natural person other than a
nonresident alien, provided that each partner’s share of
any partnership item is the same as his or her distributive
share of every other partnership item. A husband and
wife and their estates are treated as one partner for the
purpose of the small partnership rule. The tax return,
and not the partnership agreement, is used to determine
whether a partnership is a small partnership (Harrell,
91 TC 242 (1988); Z-Tron Computer Research and
Development Program, 91 TC 258 (1988)). The IRS
does not have to determine whether a reported unequal
allocation of a partnership item was correct in order to
apply the test for the small partnership exception (Nehrlich, CA-9, 2009-1 USTC ¶50,394).
A small partnership that is exempt from the consolidated
audit procedures can elect to be subject to them (Code
Sec. 6231(a)(1)(B)). The election is binding for the year
in which it is made and for all future years until it is
revoked with the permission of the IRS.
Tax Matters Partner (TMP) represents partnership.
The TMP must be a general partner in the partnership.
The TMP cannot be a limited partner or simply an employee without a general partnership interest. If there is
no general partner designated as a TMP, then the TMP
is the general partner having the largest profits interest at
the close of the year. If more than one general partner fits
this description, then the TMP is the first such general
partner in alphabetical order.
If there is no general partner designated as the TMP and
it is impractical to apply the TMP designation to the
general partner with the largest profits interest, then the
TMP is the general partner designated by the IRS (see
Rev. Proc. 88-16, 1988-1 CB 691, as corrected by Announcement 88-67, IRB 1988-16, 36, for circumstances
under which the IRS will choose a TMP).
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MODULE 2 — CHAPTER 8 — Completing the Return
There have been a number of cases determining who
the TMP is:
designated person, then each member is treated as a
member-manager, so any owner can serve as TMP.
A TMP need not have any personal tax liability at
stake in order to represent the partnership (Gateway
Hotel Partners, LLC, TC Memo 2009-128).
Person continued to be TMP even though he resigned as a partner from the partnership because he
had not resigned as TMP, the partnership had not
designated another TMP, and of two equal partners,
his name would have appeared first in an alphabetical
listing (Monetary II Ltd Partnership, CA-9, 95-1
USTC ¶50,073).
Person under criminal investigation continued to
be TMP because he had not received notice of the
investigation nor written notice from the IRS of the
conversion of partnership items to non-partnership
items (Miller, Bankr. Appellate Panel, CA-9, 95-1
USTC ¶50,106). Similarly, partnership items become nonpartnership items on the date the partner
is notified that he or she is the subject of a criminal
investigation (Phillips, 114 TC 115 (2000)).
Person who was sole remaining general partner became TMP even though partnership did not make the
designation (Transpac Drilling Venture, 1983-2,
Fed. Claims Ct., 95-1 USTC ¶50,192).
Tax shelter promoter who had acted as TMP for
a partnership and agreed to extend the statute of
limitations after IRS started a criminal investigation
but later argued that he ceased to be the TMP and,
in fact, IRS stepped into his shoes, once the criminal
investigation began and, so was not authorized to act
on behalf of the partnership was still TMP (Miller,
CA-9, 96-1 USTC ¶50,236).
Tax Court has held that a partner who holds himself
out as a TMP can bind the partnership even though
such partner was never officially designated as the
TMP (Cascade Partnership, TC Memo 1996-299).
Procedures for consolidated audits. The IRS is required
to give notice of the commencement and the conclusion
of administrative proceedings to each partner (other than
one owning less than a 1% interest in a partnership with
more than 100 partners) (Code Sec. 6223).
LLCs using partnership reporting are also subject to
the consolidated audit procedures. Only a membermanager can be designated as a TMP for an LLC (Reg.
§§301.6231(a)(7)-1 and 301.6231(a)(7)-2).
A member-manager is a person who, alone or with others, has continuing exclusive authority to make management decisions necessary to conduct the business for
which the organization was formed. If there is no such
1065 prep_10_book.indb 71
71
There can be no tax assessment until a final partnership
administrative adjustment is issued (FPAA). Notice
of an FPAA is not invalid merely because it does not
specify the TMP (Orphir Mine, TC Memo 1992-119).
However, the Tax Court lacked jurisdiction over an atrisk issue where it was not a partnership item subject to
an FPAA (Sealy Power, Ltd., TC Memo 1992-168).
The TMP may commence judicial proceedings within
90 days of the mailing of the notice of the FPAA. The
IRS may assess tax against a partner within three years
of the filing of the partnership return or its original due
date, whichever is later (Code Sec. 6229). The TMP
may consent to extend the statute of limitations for all
partners (Code Sec. 6224(c)(3)). The three-year statute
of limitations period is a minimum period (AD Global
Fund, LLC, CA-FED, 2007-1 USTC ¶50,312).
A six-year statute of limitations applies if the partnership
omits from gross income an amount in excess of 25%
of its gross income stated on the return; if no return is
filed, the tax can be assessed at any time. A court has
determined that for purposes of the six-year statute of
limitations, an overstatement in basis is not treated as
an omission, so the three-year limitation period applies
(Grapevine Imports Ltd., FED CL, 2007-2 USTC
¶50,555; Bakersfield Energy Partners, LP, 128 TC
No. 17 (2007)).
Request for an administrative adjustment. A partner
or the TMP may request a refund by filing a request for
an administrative adjustment within certain time limits
(Code Sec. 6227).
In the case of a bankrupt partnership, the tolling of the
statute of limitations against the partnership applies
to the partners as well (Wright, CA-7, 95-2 USTC
¶50,334).
The topic of filing the return is discussed in Chapter 1.
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STUDY QUESTIONS
2.
Partners must report items consistently with the
partnership return or notify the IRS of any inconsistent treatment. True or False?
3.
Except in the case of small partnerships, audits of
partnership items are conducted at the partnership
level. True or False?
4.
With respect to audits of small partnerships, which
of the following statements is correct?
a. Small partnerships are automatically exempt
from the consolidated audit procedures.
b. Small partnerships may elect to be exempt
from the consolidated audit procedures.
c. Small partnerships cannot use the consolidat-
ed audit procedures under any circumstances.
5.
The Tax Matters Partner can extend the statute of
limitations on behalf of all partners. True or False?
CPE NOTE: When you have completed your study
and review of this Module, you may wish to take the
Quizzer for this Module.
For your convenience, you can also take this Quizzer
online at www.cchtestingcenter.com
1065 prep_10_book.indb 72
11/6/2009 3:30:20 PM
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
CHAPTER 5 — Schedules L, M-1, M-2 and M-3
While “total receipts” is one requirement, it is not the only requirement for exemption from
completing Schedule L.
b. Incorrect. While “total assets” is one requirement for
exemption it is not the only requirement.
c. Incorrect. While furnishing Schedules K-1 is one requirement for exemption is it not the only requirement.
d. Correct. Only partnerships that meet the total
receipts, total assets and Schedule K-1 requirements
are exempt from completing Schedule L.
1. a. Incorrect.
2. True. Incorrect. Tax-exempt securities may not be
omitted from the balance sheet.
False. Correct. Instructions to Form 1065 explain
that tax-exempt securities must be included in the
balance sheet.
3. a. Incorrect.
Line 18 does not include recourse
loans.
Nonrecourse loans that are personally
guaranteed by members are not considered nonrecourse
and, so, are not included on line 18.
c. Correct. Line 18 is for reporting nonrecourse loans
and all liabilities are treated as nonrecourse loans
unless personally guaranteed by members.
b. Incorrect.
4. a. Incorrect. Gross income is not used to reconcile
book income with tax return income.
b. Incorrect. Taxable income is not used to reconcile
book income with tax return income.
c. Correct. Net income from the partnership books
as of the close of the year is the figure adjusted for
reconciliation.
5. a. Incorrect.
Undeducted depreciation is an addi-
tion item.
b. Incorrect. 50% of meal costs
c. Correct. While guaranteed
is an addition item.
payments are an addition, health insurance included in guaranteed
payments is not.
Distributions to partners affecting
their capital accounts are reflected in Schedule M-2.
False. Incorrect. Changes in the partners’ capital accounts is the only purpose for Schedule M-2.
6. True. Correct.
1065 prep_10_book.indb 88
Being required to complete Schedules L, M-1 and M-2 does not automatically require the
completion of Schedule M-3.
False. Correct. Only partnerships meeting any one of
four criteria must complete Schedule M-3.
7. True. Incorrect.
CHAPTER 6 — Schedule K
There is no exemption for small
partnerships from completing Schedule K.
False. Correct. All partnerships must file Schedule K.
1. True. Incorrect.
2. a. Incorrect. Gross income does include gain or loss
from an involuntary conversion of a rental property.
b. Correct. Income from a rental activity incident to a
nonrental activity is excluded from gross income from
rental real estate activities under Reg. §1.469-1T.
c. Incorrect. Gross income does include amounts paid
for the rental of partnership property.
3. True. Incorrect. The partners may not make this election.
False. Correct. The partnership, not the partners,
make the election out of installment reporting.
4. a. Incorrect. The basic limit for 2009 is $250,000.
b. Incorrect. The dollar limit does apply at both the
partnership and partner levels.
c. Correct. The dollar limit applies at both the owner
and entity levels.
Partners who are individuals must
be able to figure their AGI limits on charitable contributions.
False. Incorrect. Partners, not the partnership, reduce
partnership income by charitable contributions.
5. True. Correct.
A general partner is subject to self-employment tax on his/her distributive share of partnership
income without regard to services performed.
b. Correct. A limited partner’s distributive share
is excluded from self-employment income; only
guaranteed payments for services performed are
includible.
c. Incorrect. While there is no IRS final guidance on
the treatment of an LLC member’s distributive share of
LLC income, it would seem fairly certain that a member
who works for the LLC would not be able to exclude the
distributive share.
6. a. Incorrect.
11/6/2009 3:30:22 PM
ANSWERS TO STUDY QUESTIONS — Chapter 8
Even though tax-exempt interest is not
includible in income–by the partnership or the partners–
it must still be reported to the partners so they can take
it into account on their personal returns.
b. Incorrect. There is no line for reporting tax-exempt
interest on page 1 of Form 1065; nor are there instructions to report the interest along with “other income.”
c. Correct. Tax-exempt interest must be separately
reported to partners to enable them to report the
interest on their personal returns; it may affect the
taxation of Social Security benefits.
7.a. Incorrect.
CHAPTER 7 — Schedule K-1
1. True. Correct. The schedule tells partners their dis-
tributive share of partnership items, enabling partners
to report the items on their own income tax return.
False. Incorrect. There is no other purpose for Schedule
K-1; a partnership is never a separate taxpayer.
2. a. Incorrect. Special allocations are only permitted if
they have substantial economic effect.
b. Correct. There must be substantial economic effect
to any special allocations.
c. Incorrect. Special allocations are permitted, provided
they qualify under the substantial economic effect
regulations.
3. a. Incorrect. A nominee must receive a Schedule K-1.
b. Incorrect. Every person who had any interest in
the partnership at all during the year must receive a
Schedule K-1.
c. Correct. Partners at the end of the year are not the
only persons to receive a Schedule K-1.
Final regulations allow for this
booking-up to reflect market values when the partner
perform services for the benefit of the partnership if he/
she is an existing partner acting in a partnership capacity
or is a new partner acting in a partnership capacity or in
anticipation of becoming a partner (T.D. 9126).
False. Incorrect. Line N is not necessarily a static reflection of a partner’s capital account and can be adjusted
for various purposes.
4. True. Correct.
The partner’s basis in the partnership
interest is increased by the partner’s basis in the
contributed property.
5. a. Correct.
1065 prep_10_book.indb 89
89
The partner’s basis in the partnership interest may not be increased by the fair market value of
contributed property.
c. Incorrect. The partner’s basis in the partnership interest is adjusted for the contribution and may be increased
by a partner’s basis in the contributed property.
b. Incorrect.
6. a. Incorrect. While these losses do reduce basis, they
are not the only reduction in basis.
b. Incorrect. While these expenses do reduce basis, they
are not the only reduction in basis.
c. Correct. A partner’s distributive share of capital
losses and expenses not deductible in computing
partnership income reduce the partner’s basis in the
partnership interest.
A partner’s basis may never be reduced below zero.
False. Incorrect. A partner’s basis may never be negative number.
7. True. Correct.
CHAPTER 8 — Completing the Return
1. a. Correct. The law only requires one general
partner to sign the return.
b. Incorrect. The signer need not be the TMP.
c. Incorrect. A limited partner may not sign the return.
2.True. Correct. Partners must use consistent treatment or file Form 8082 to notify the IRS of inconsistent treatment.
False. Incorrect. Partners are not free to characterize
items on their personal returns as they please and must
follow partnership treatment.
3. True. Correct. The
consolidated audit procedures
are conducted at the partnership level.
False. Incorrect. The individual partners are not separately audited with respect to partnership items.
4. a. Correct. Partnerships with 10 or fewer partners
are audited on the partner level unless they elect to
apply the consolidated audit procedures.
b. Incorrect. No election is required by a small partnership to be exempt from the consolidated audit procedures; exemption is automatic.
c. Incorrect. Small partnerships may use the consolidated audit procedures if they make an election to do so.
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
The TMP has the authority to act
on behalf of all the partners.
False. Incorrect. Extension of the statute of limitations
is not made on a partner-by-partner basis.
5. True. Correct.
A change in the profits interest without
a change in the capital interest does not result in a
termination.
c. Incorrect. A change in a capital interest without a change
in the profits interest does not result in a termination.
b. Incorrect.
CHAPTER 9 — Distributions
If cash distributions exceed a partner’s
basis in the partnership, the excess is recognized as
income.
b. Incorrect. The basis of property distributed to a partner must be reduced to the extent that the distribution
exceeds the partner’s basis in the partnership interest.
c. Correct. This statement is untrue because distributions of marketable securities are treated like cash
distributions.
1. a. Incorrect.
2. True. Correct. Code Sec. 731 reduces the partner’s
basis for current distributions.
Distributions may not be received
without reducing basis (but not below zero).
False. Incorrect.
3. a. Incorrect.
Loss can be recognized in this circum-
stance.
b. Correct. Loss may not be recognized on the distri-
bution of property other than unrealized receivables
and substantially appreciated inventory.
c. Incorrect. Gain related to unrealized receivables and
substantially appreciated inventory must be treated as
ordinary income.
2. True. Incorrect. A partner’s retirement does not always
result in a termination.
False. Correct. Retirement may or may not cause a
termination.
A transfer by gift is not a sale so it is
not a termination.
False. Correct. The partnership does not terminate
upon the gift of this interest.
3.True. Incorrect.
The end of the tax year is a consequence of termination.
False. Incorrect. The tax year of a terminated partnership does not continue after termination.
4. True. Correct.
5. a. Correct. The partners’ loss is ordinary loss.
b. Incorrect. Even though the partners made an invest-
ment in the partnership, their loss on abandonment of
their interest is not a capital loss.
c. Incorrect. Taxable gain results only when the partners’
capital account has a negative balance.
CHAPTER 11 — Sale of a Partnership Interest
1. True. Correct. The tax year ends automatically with
4. True. Correct. The concept of unrealized receivables is one that is generally applicable to fee-based
businesses, which are usually cash basis businesses.
False. Incorrect. Unrealized receivables generally do not
apply to inventory-based businesses that use the accrual
method of accounting which take items into income
under the economic performance test.
respect to the partner—it may also end with respect
to the partnership if there is a more than 50% change
in interest.
False. Incorrect. The partnership year does not continue
with respect to the selling partner.
2. True. Correct.
This reflects the instructions to
Form 1065.
5. a. Incorrect. The optional basis adjustment can apply
in this case.
The optional basis can apply if loss is
recognized.
c. Correct. The optional basis can apply only if basis is less
than or exceeds basis in the hands of the partnership.
False. Incorrect. Partnerships are not given the option
of reporting these transfers and must do so.
b. Incorrect.
CHAPTER 10 — Terminations of Partnerships
3. a. Correct. The third party-buyer, as a sole owner,
may not continue the partnership.
b. Incorrect. The selling members are required to report
gain or loss on the transaction.
c. Incorrect. The third party-buyer is required to report
gain or loss on the deemed-distributed assets.
1. a. Correct. There must be a change in both the capi-
tal and profits interest for a termination to result.
1065 prep_10_book.indb 90
11/6/2009 3:30:23 PM
1065 PREPARATION AND PLANNING GUIDE
Quizzer Questions: Module 2
40.
NOTE: Unless otherwise indicated, assume that the
partnership in question is on a calendar-year basis
for 2009.
36.
It must be filed by all entities treated as partnerships and that file Form 1065.
b. It does not have to be filed by any partnership
exempt from filing Schedule L.
c. A copy of Schedule K must be furnished to each
partner.
a.
All of the following statements regarding Schedule
L, Balance Sheet, are correct except:
All partnerships are required to complete it.
The balance sheet reports items from the partnership’s books and records.
c. Differences between the partnerships books
and records and amounts reported on Schedule
L must be reported on a separate schedule attached to the return.
a.
b.
37.
Schedule M-1 is not completed if the partnership is not required to complete Schedule L.
b. All partnerships are required to complete Schedule M-1.
c. Schedule M-1 is used to reconcile income per
books with income per return.
d. The starting point for completing Schedule M-1
is accounting income.
38.
Which of the following is a decrease to book (accounting) income on Schedule M-1:
a.
b.
c.
39.
41.
Tax-exempt interest
Depreciation claimed on Schedule K
Travel and entertainment expenses
Schedule M-2 is used to show what caused any
changes in the partners’ capital accounts. True
or False?
1065 prep_10_book.indb 153
Guaranteed payments to partners include all of the
following payments to or on behalf of the partners
except:
Health insurance coverage for partners
Interest deducted by the partnership that was
reported on line 10, page 1 of Form 1065
c. Distributive share of partnership profits
a.
b.
All of the following statements regarding Schedule
M-1 are true except:
a.
With respect to Schedule K, which of the following
statements is true?
42.
Other income reported in the catchall income
entry on Schedule K includes all of the following
except:
Gain from depreciation recapture
Gain from the disposition of an interest in oil,
gas, geothermal, or other mineral properties
c. Recovery of tax benefit items
d. Section 1231 gain
a.
b.
43.
The dollar limit on the first-year expensing deduction for 2009 is (assuming the property is
not eligible for an enhanced Sec. 179 deduction
amount):
a.
b.
c.
d.
$25,000
$125,000
$133,000
$250,000
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1 0 6 5 P R E PA R AT I O N A N D P L A N N I N G G U I D E
44.
With respect to the Section 179 deduction, all of
the following statements are true except:
If the election is made, the partner must reduce
his or her partnership basis even if the deduction
is not fully utilized.
b. The partner can carry forward any portion of
the deduction unused because of application of
the dollar limit
c. The election is made at the partnership level
d. The taxable income limit applies at both the
partnership and partner levels.
49.
The partnership must compute its alternative
minimum tax.
b. The partnership can elect an optional 10-year
write-off for certain preferences.
c. Adjustments and tax preferences pass through
to partners so they can figure AMT on their
individual returns.
a.
45.
a.
50.
Other deductions reported in the catchall line on
Schedule K include all of the following except:
Penalty on early withdrawal from time deposit
accounts
b. Charitable contribution deductions
c. Soil and water conservation expenditures
d. Medical insurance for partners, spouses, and
dependents
47.
In figuring self-employment tax on self-employment income on Schedule K, which of the following
statements is true:
Rental income is always part of all self-employment income (whether or not the real estate
activity is a trade or business).
b. Limited partners are not subject to self-employment income on their distributive share of
partnership income.
c. The IRS has ruled that all limited liability
company members must pay self-employment
tax on their distributive share of income from
the LLC.
Foreign taxes
Recapture of first-year expensing
Taxes paid on undistributed capital gains by a
regulated investment company
All of the following statements about Schedule K-1
are correct except:
Schedule K-1 puts into operation the passthrough nature of the form by allocating to
each partner his or her distributive share of
partnership items.
b. A copy of Schedule K-1 must be furnished to
each partner.
c. Schedule K-1 cannot reflect any special allocations made in a partnership agreement, even if
they have substantial economic effect.
a.
Low-income housing credit
Disabled access credit
Credit for small employer pension plan startup costs
a.
48.
51.
All of the following credits are reported as other
credits on Schedule K except:
a.
b.
c.
Items required to be reported separately on line 20c
of Schedule K include all of the following except:
a.
b.
c.
a.
46.
With respect to alternative minimum tax, which of
the following statements is true?
52.
Adams and Bradley are 50/50 partners in the AB
Partnership. The partnership agreement says that
everything will be split 50/50. The partnership’s
income from trade or business is $100,000. Line 1
of Adams’ Schedule K-1 reports which of the following amounts:
a.
b.
c.
d.
Zero
$50,000
$100,000
None of the above
Self-employment income included on Schedule K
includes all of the following except:
Guaranteed payments to general partners
General partners’ distributive share of the partnership’s net income from its business
c. Rentals from real estate that are not received
in the ordinary course of business allocable to
general partners
a.
b.
1065 prep_10_book.indb 154
11/6/2009 3:30:48 PM
QUIZZER QUESTIONS — MODULE 2
53.
With respect to Schedule K-1, all of the following
statements are true, except:
Only one Schedule K-1 need be furnished to a
husband and wife who are both partners in the
partnership, regardless of how they hold title to
their partnership interests (assuming that they
are not the sole partners and have not elected
not to file Form 1065).
b. Schedule K-1 is required for each person who
was a partner at anytime during the year.
c. For a calendar year partnership that files its
return by April 15, Schedule K-1 must be sent
to each partner by April 15th.
57.
Losses in excess of a partner’s basis in his partnership
interest can be:
Carried forward until there is basis to offset the
losses
b. Carried forward only for a limited period
c. Deducted in the current year
a.
58.
A partner’s basis in the partnership can be increased
by all of the following except the partner’s:
a.
b.
c.
d.
56.
Distributive share of partnership income
Distributive share of tax-exempt income
Additional capital contributions
Distributive share of partnership losses
With respect to capital gains of the partnership,
which statement is not correct?
Schedule D is used to list short-term and longterm transactions.
b. Gains are taxed to the partnership.
c. Schedule D is used to elect out of installment
method reporting.
a.
59.
a.
55.
In entering income of the partnership on line 1 of
Schedule K, which statement is correct?
Enter ordinary income or loss from the activities
of the partnership.
b. Apply at risk limitations.
c. Do not enter less than zero.
a.
54.
155
Partnerships are exempt from substantiation requirements when making charitable contributions.
True or False?
60.
Each of the following can be a tax matters partner
(TMP) except a:
Limited partner
General partner with the largest profits interest
at the close of the year
c. General partner designated by the IRS
a.
b.
Increases to accounting income on Schedule M-1
include all of the following except:
a.
b.
c.
1065 prep_10_book.indb 155
Business gifts in excess of $25
The cost of spousal travel
Proceeds from key person life insurance
11/6/2009 3:30:48 PM
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