Information Returns (Part 2 of 2)
Common Information Returns were discussed in the October, 2010 edition of Tax Law Explained . This is the second part of that discussion and covers Schedule K-1’s issued by Partnerships, Limited Liability Companies (LLC’s) taxed as Partnerships, S Corporations, Estates and Trusts. For sake of discussion, in this article any entity that issues a Schedule K-1 will be referred to as a “Reporting Entity” and any entity that receives a Schedule K-1 will be referred to as a “Recipient”.
Schedule K-1’s are the method by which Partnerships, LLC’s taxed as Partnerships and S Corporations report tax information to its owners (whether a partner, member or shareholder) and how Estates and Trusts report tax information to its beneficiaries. While Reporting Entities must file Federal Income Tax Returns, they are flow-through entities that generally do not pay Federal Income Tax themselves. Instead, the information is passed on to the Recipients who then integrate that information onto their own income tax returns.
The Federal Income Tax laws have a variety of categories for income and expenses. For example, Recipients must report interest income differently from long-term capital gains. Accordingly, Schedule K-1’s must provide Recipients with information, category by category. Some of the information on Schedule K-1’s must be reported directly by the Recipient (e.g. Interest and long-term capital gains) while other information must simply be known by the Recipient in order to determine how information is to be reported by them (e.g. distributions of cash may constitute taxable income but does affect Basis).
The information reported on Schedule K-1’s is not affected by the Recipient’s entity type. For example, the Schedule K-1 issued by a Partnership would be the same whether the partner happens to be an individual, Partnership, S Corporation, C Corporation, Estate or Trust.
There is a burden on Reporting Entities to issue complete and accurate Schedule K-1’s. Most information will fit neatly within the category of a particular box. For example, interest in come and dividend income have their own separate box. Information that does not have its own separate box can be reported in the box entitled “Other Information” and is often supplemented with an explanation attached to the Schedule K-1.
If a Recipient believes that information reported to them on a Schedule K-1 is incorrect they can try to get the Reporting Entity to issue a “corrected” Schedule K-1. If that does not work, the Recipient is allowed to report the item inconsistent from how it is shown on the Schedule K-1 so long as they clearly inform the IRS of what it is, and why they are treating it inconsistent from the Schedule K-1.
Similarities Among All Schedule K-1’s:
Here are the Schedule K-1 categories that are the same for all Reporting Entities:
- The name, address and EIN of the Reporting Entity and Recipient.
- Ordinary Business Income (Loss).
- Net Rental Real Estate Income (Loss).
- Other Rental Income (Loss).
- Interest Income.
- Ordinary Dividends
- Qualified Dividends.
- Net Short-Term Capital Gain (Loss).
- Net Long-Term Capital Gain (Loss).
- Unrecaptured Section 1250 Gain(Loss).
- Other Income.
- Alternative Minimum Tax Adjustments.
- Foreign Transactions and Credits.
- Tax Exempt Income.
- Other Information.
Special Items on Partnership Schedule K-1’s:
There are a few items unique to Partnerships that are reported only on Schedule K-1’s issued by Partnerships.
- Guaranteed Payments. Entities taxed as Partnerships have a tax concept called “Guaranteed Payments”. In general, Guaranteed Payments represents the payments that the Partnership must make to a particular partner regardless of the income or loss of the Partnership. Guaranteed Payments are mostly commonly paid for services or for the use of capital. Guaranteed Payments are separately stated on Part III, Line 4 of a Partnership’s Schedule K-1.
- Self-Employment Earnings (Loss). As discussed more fully in a prior Tax Law Explained article, employees’ wages are subject to Social Security and Medicare tax (FICA). While partners generally do not earn “wages” the Federal Government still wants to collect “employment” type taxes. Accordingly, certain income flowing to partners is subject to something called “Self-Employment” tax (SE). SE tax to self-employed people is equivalent to what FICA is to employees (both the employee and employer portions). SE income is separately stated on line 14 of the Schedule K-1 issued by the Partnership.
- Partners Share of Partnership Liabilities. There are various “Basis” and “At-Risk” issues to partners and S Corporation shareholders. Briefly, Basis and At-Risk affects such things as whether a Recipient can deduct losses reported to them on their Schedule K-1, what the gain or loss is upon disposition of their ownership interest and whether distributions of cash or property results in a taxable event. Partners of Partnerships might get “Basis” for money borrowed by the Partnership.
Accordingly, Part II, Section K of the Schedule K-1 issued by a Partnership reports the allocation of Partnership liabilities to that partner.
It should be noted that LLC’s do not have a comprehensive set of Income Tax laws. LLC’s are like chameleons:
- Partnership: LLC’s with 2 or more members are taxed as though they were a General Partnership unless they elect otherwise. In this event, the LLC taxed as a Partnership files a Form 1065.
- Sole Proprietor: LLC’s with only 1 member are treated as Sole Proprietors. Individuals reflect their business activities on a Schedule C attached to their Form 1040. There is no Schedule K-1.
- C Corporation: LLC’s can file Form 8832 and elect to be taxed as though they were a C Corporation (Form 1120). There is no Schedule K-1.
- S Corporation: LLC’s can file Form 8832 and elect to be taxed as though they were an S Corporation (Form 1120S).
Recipients rely upon Reporting Entities to prepare complete and accurate Form W-2, Form 1099, Schedule K-1 and other Informational Returns. However, Recipients may have exposure for reporting information consistent with the Informational Return if the Informational Return is incorrect.
Reporting Entities must use Schedule K-1’s to correctly report information to Recipients.
Recipients, must then take that information and correctly integrate it onto their own
Income Tax Return. Schedule K-1’s can be tricky to prepare and tricky to use by the
Recipient. As with many other areas of the law, taxpayers are encouraged to seek the assistance of a trained tax advisor in dealing with Schedule K-1’s.
Copyright ©, Keith B. Baker – 2010
This article is designed to be a public resource of general information. It does not constitute “legal advice” nor does it create a “client-attorney” relationship. While the information is intended to be accurate, this cannot be guaranteed. Tax laws are complex and constantly changing as a result of new laws, regulations, court interpretations and IRS pronouncements. Often, there are also various possible interpretations. Further, the applicable rules can be affected by the facts and circumstances of a particular situation. Because of this, some of the information may no longer be correct or may not apply to all situations. We are not responsible for any consequences or losses resulting from your reliance on such information. You are urged to consult an experienced lawyer concerning your particular factual situation and any specific legal questions you may have.
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