How Are Partnership Taxes Calculated and Filed?
Understand the distinct tax duties of a partnership and its owners, from the entity's calculations to how each partner reports their share on a personal return.
A partnership is a business structure with two or more individuals who share in its profits and losses. The defining characteristic of a partnership’s tax treatment is “pass-through taxation,” which means the business entity itself does not pay income tax.
Instead, all income, losses, deductions, and credits are passed directly to the individual partners. Each partner is then responsible for reporting their share of these financial outcomes on their personal tax returns, a system that avoids the double taxation common to corporations.
The Partnership’s Annual Information Return
Each year, a partnership must file Form 1065, U.S. Return of Partnership Income, with the IRS. This information return reports the partnership’s income, deductions, gains, and losses and is not used to pay tax. To complete it, the partnership gathers financial data like gross receipts and operational expenses, including rent, salaries for non-partner employees, and taxes. The filing deadline for a calendar-year partnership is March 15th of the following year.
When preparing Form 1065, the partnership must distinguish between ordinary business income and separately stated items. Ordinary business income is the net profit or loss from the partnership’s primary activities. Financial items subject to special tax rules on an individual’s return must be reported separately so they retain their tax character as they pass to the partners. This separation ensures each partner can apply their own individual tax limitations.
Common examples of separately stated items include:
- Short-term and long-term capital gains and losses
- Charitable contributions made by the partnership
- Investment interest income
- Section 179 deductions
Issuing Schedule K-1 to Partners
After completing Form 1065, the partnership allocates its financial items among the partners according to the partnership agreement, reporting each partner’s share on a Schedule K-1. A unique K-1 must be prepared for every partner and furnished to them by the March 15th filing deadline. The partnership also files copies of all K-1s with the IRS.
The K-1’s structure breaks down the partnership’s total financial activity into individual shares. For example, one box shows the partner’s share of ordinary business income, while other boxes detail their share of separately stated items like net rental real estate income, interest income, or capital gains.
Individual Partner Tax Reporting
Upon receiving a Schedule K-1, the partner transfers the information to their personal tax return, Form 1040. The boxes on the K-1 guide the partner on where to report each item. For example, ordinary business income from Box 1 is reported on Schedule E (Form 1040), Supplemental Income and Loss.
Other items from the K-1 are reported on different schedules. A partner’s share of net long-term capital gains from Box 9a is transferred to Schedule D, Capital Gains and Losses. Similarly, royalty income from Box 7 flows to Schedule E, and charitable contributions from Box 13 are reported on Schedule A, Itemized Deductions.
General partners are typically responsible for paying self-employment tax on their share of the partnership’s ordinary business income. For 2025, the self-employment tax rate is 15.3%, consisting of 12.4% for Social Security on the first $176,100 of earnings and 2.9% for Medicare on all earnings. Limited partners are generally only subject to self-employment tax on guaranteed payments they receive for services.
Understanding Partner’s Basis
A partner’s basis represents their economic investment in the partnership for tax purposes. A partner’s initial basis is typically the amount of cash they contributed plus the adjusted basis of any property they transferred to the partnership. This figure is adjusted annually to reflect the partnership’s operations and transactions with the partner.
Basis increases with the partner’s share of income and any additional contributions. It is decreased by the partner’s share of losses and by any distributions of property or cash they receive. For example, a $50,000 starting basis, increased by $10,000 of income and decreased by a $5,000 distribution, results in an ending basis of $55,000.
The partner’s basis serves two functions. First, it limits the amount of partnership losses a partner can deduct on their personal return, as losses cannot exceed their basis. Any excess losses are carried forward to future years. Second, basis is used to calculate the taxable gain or loss when a partner sells their interest or the partnership liquidates.