How to File a 1065 Final Return for a Partnership
Understand the tax process for dissolving a partnership, from reconciling the entity's final accounts to the reporting requirements for individual partners.
Form 1065, U.S. Return of Partnership Income, is an informational return used by domestic partnerships to report financial activity to the IRS. As pass-through entities, partnerships do not pay income tax; instead, profits and losses are passed to the partners. Filing a final return indicates the partnership has ceased all operations and is closing its books with the IRS.
Events Requiring a Final Partnership Return
A partnership must file a final Form 1065 when it terminates for tax purposes by completely ceasing all business activities. This means the partnership is no longer engaged in any trade, financial operation, or venture. For example, a retail partnership that sells all inventory, closes its store, and settles its debts must file a final return. The partnership’s tax year ends on this termination date, and the final return covers the period from the beginning of the tax year up to that date.
Required Information and Final Calculations
Before filing, the partnership must perform several calculations and gather specific financial data. All income and expenses up to the date of dissolution must be tallied. This includes revenue from final sales, payments for outstanding bills, and any operational costs paid during the winding-down period.
If the partnership sold business assets like equipment or real estate, it must calculate the gain or loss from these sales. This requires documenting the asset’s original cost, the total depreciation claimed, and the final sale price. These figures are reported on Form 4797, Sales of Business Property, and the result flows through to Form 1065.
The partnership must also complete the following financial reconciliations:
- Prepare the final balance sheet on Schedule L. For a liquidated partnership, this schedule must show zero assets and liabilities at the end of the tax year, proving all accounts are settled.
- Perform a final reconciliation of each partner’s capital account on Schedule M-2. This involves adjusting for the final period’s income or loss and any final distributions, bringing each partner’s ending balance to zero.
- Keep a detailed record of all liquidating distributions made to partners, including cash and the fair market value of any property. This information is needed for each partner’s final Schedule K-1.
The Filing Process for a Final Return
On the first page of Form 1065, a box in Section G must be checked to indicate that this is a “final return.” Missing this step can lead to the IRS expecting future returns and issuing failure-to-file notices. Similarly, each partner’s corresponding Schedule K-1 must be marked as final by checking the “Final K-1” box in Part II, item J.
The complete filing package includes Form 1065, a Schedule K-1 for every partner, and any other required forms, such as Form 4797 for asset sales. The partnership can file this package electronically using IRS-approved tax software or mail a paper copy to the address specified in the Form 1065 instructions.
The due date for a final partnership return is the 15th day of the third month after its tax year ends. For a partnership that terminates on December 31, the deadline is March 15 of the following year. An automatic six-month extension can be requested using Form 7004.
Tax Implications for Individual Partners
Upon receiving their final Schedule K-1, partners report their share of the partnership’s final income, losses, and deductions on their personal income tax returns. For instance, a partner’s share of ordinary business income is reported on Schedule E of their Form 1040.
The partnership’s dissolution is a separate tax event for each partner. Partners must calculate a capital gain or loss on the liquidation of their interest, which is distinct from the operational income or loss on the K-1. To determine this gain or loss, a partner compares their final adjusted basis in the partnership to the total liquidating distributions received.
The adjusted basis is the partner’s original investment, increased by subsequent contributions and their share of income, and decreased by distributions and their share of losses. If the cash received exceeds the partner’s adjusted basis, the excess is a capital gain.
A partner may recognize a capital loss if they receive only cash, unrealized receivables, and inventory in a distribution that is less than their adjusted basis. The character of the gain or loss—whether it is short-term or long-term—depends on how long the partner held their partnership interest. This final gain or loss is reported on Schedule D of the partner’s Form 1040.