Tax Form 1065, also known as a “Partnership Tax Return,” is how businesses classified as partnerships report their financial information to the IRS. Partnerships are “pass-through” entities and don’t have their own tax rate. What this means is that their profits and losses pass through directly to their owners. Generally, no taxes get paid with Form 1065 because this is an informational return.
Who Must File Form 1065?
The IRS defines a partnership as two or more people who carry on a trade or business together. Each person contributes money, skill, labor, or property with the expectation that all partners will share in the profits and losses.
All domestic business partnerships must file Form 1065. This includes multi-member limited liability company’s (LLCs) and possibly husband-and-wife owned businesses (although, there are different options for husband-and-wife- owned businesses in community property states).
Foreign partnerships with income in the US must also file Form 1065. Foreign partnerships are excluded from filing if the partnership meets any of the following conditions during its tax year:
· The partnership had no effectively connected income (ECI).
· The partnership had US earnings of $20,000 or less.
· Less than 1% of any partnership item of income, gain, loss, deduction or credit was allocable in the aggregate to direct US partners.
· The partnership had no US partners at any time.
· And a few others that are covered here.
Nonprofit religious organizations exempt from tax under section 501(d) also file this form. They must show that profits were given to their members as dividends, regardless of if the dividends were actually distributed. These religious or apostolic organizations must also make their information return available for public inspection, which includes an exact copy of Form 1065 and all accompanying schedules and attached statements, except K-1.
When to File Form 1065
A domestic business partnership return should be filed on or before the 15th day of the third month following the date its tax year ended. So, for calendar-year partnerships, the due date is March 15. If the due date falls on a Saturday, Sunday, or legal holiday in the District of Columbia, then the due date is the next business day that isn’t a Saturday or Sunday.
Penalties are assessed if the partnership neglects to file the return by the due date or if it fails to show all the information required, unless due to reasonable cause. The penalty for 2020 returns is $210 per month or part of a month multiplied by the number of partners who were partners anytime during the tax year the failure continues for a maximum of 12 months.
Where to File Form 1065
Partnerships have the option to either electronically file or mail in the return. Certain partnerships with more than 100 partners are required to file Form 1065, Schedules K-1, and related forms and schedules electronically. If the partnership elects to mail their tax return, they will need to know the state of the principal business office and the total assets in order to locate the filing address here. Bankruptcy returns and returns with pre-computed penalties and interest must be mailed. Partnerships may choose to file for an automatic six-month extension by completing Form 7004 by the regular due date of the partnership return.
How to file Form 1065
If you are a partner in a partnership, there are two steps involved in reporting your portion of partnership income or losses for tax purposes.
First, the partnership reports total net income and all other relevant financial information for the partnership using Form 1065. Included with this return is a Schedule K-1 for each partner allocating their portion of the partnership income or loss along with other pertinent information.
Second, each individual partner then prepares their own personal tax return including their portion of the partnership’s income and other deductions from their Schedule K-1 on a Schedule E, “passing through” the partnership income to their owners.
In order to file Form 1065, you’ll need all of your partnership’s important year-end financial statements, including a profit-and-loss statement that shows net income and revenues, a list of all the partnership’s deductible expenses, and a balance sheet for the beginning and end of the year.
You’ll also need your Employer Identification Number (also known as your Tax ID), your Business Code Number, the number of partners in your business and their information (name, address, Tax ID, and profit-sharing percentage), start date for the business, and information about whether your company uses the cash or accrual method. Other items you may want to have handy are distributions paid out to partners beyond their standard guaranteed payments, if you paid anyone outside the partnership more than $600 to do contract work and filed Form 1099-NECs, and your partnership or organization agreement.
It is recommended to use a tax professional such as a CPA, Enrolled Agent, or Tax Attorney to professionally file Form 1065 because they have the knowledge to help you navigate answering the complicated questions posed on the form.
Form 1065 is broken into sections and then schedules. Page 1 is where you will report income, Deductions (expenses) and tax and payment information. The next few pages that follow are Schedule B, which asks 29 distinct questions about the partnership. This section also asks for the information for the designated Partnership Representative so the IRS will know who to contact if the return ever gets called into question.
Remember, partnerships are pass-through entities so Form 1065 doesn’t calculate how much tax the partnerships owes. The partnership income or losses are reported directly to partners’ using Schedule K-1. The amounts allocated on the individual K-1s are based on the information presented on Schedule K.
Not all items on the partnerships profit and loss statement get reported on page 1 of Form 1065. There are some items which are separately stated on Schedule K in addition to the ordinary business income or loss reported on page 1. These items are organized into sections:Income, Deductions, Self-Employment, Credits, Foreign Transactions, Alternative Minimum Tax (AMT) Items, and Other Information. These sections cover things such as real estate income, interest and dividend income, capital gains, foreign transactions, distributions, and any other guaranteed payments that partners may have received as part of their involvement in the partnership.
Schedule K summarizes all the partners’ shares of these items. It allocates the line items on this schedule to each individual partners’ K-1 based on their allocable share. Each partner will then file their Schedule K-1 separately on their individual tax returns.
Schedule L reports the partnership’s balance sheet. This schedule details the current and prior year’s asset, liabilities, and capital accounts.
If the answer to all four questions in part 4 of Schedule B on Form 1065 is “yes,” then the business is not required to fill out Schedule L, Schedule M-2, or Schedule M-3.
The year over year changes in the balance sheet should be consistent with the information provided about income and capital accounts on the following Schedules M-1 and M-2.
Because there are differences between generally accepted accounting principles (also known as GAAP) and tax reporting, it’s not unlikely that there will be discrepancies between what the partnership records as its net income on the books versus. what the IRS recognizes as actual taxable profits.
Schedule M-1 reconciles these differences by asking about any income, expenses, and depreciation recorded on your books that are different or not included on the tax return.
Even if there are no differences between book income and reported income, a partnership that does not meet all four requirements in part 4 of Schedule B must file Schedule M-1.
The purpose of Schedule M-2 is to inform the IRS of the changes to the partner’s capital accounts because of cash, property or any other capital contributions and distributions. This section also accounts for the impact the income or loss reported on the partnership’s profit-and-loss statement has on the capital accounts.
Schedules L, M-1 and M-2 contain items that match one another, so it’s a good idea to fill the schedules out in order. Items include as net income (loss) per books (M-1 line 1 and M-2 line 3) and/or partner’s capital accounts (Schedule L line 21 column B and D and M-2 lines 1 and 9).
Again (and as always) we highly recommend working with a professional to ensure that everything is reported and filed as required.