Why Is the K-1 Line 13W Amount Not Deducted on Your Tax Return?

The K-1 tax form reports income, deductions, and other relevant information for partners in a partnership or shareholders of an S corporation. A common point of confusion is why amounts listed on Line 13 under Code W are not directly deducted on a tax return.

Understanding how these expenses are categorized and where they should be reported is key to determining whether they can offset taxable income.

Locating Code W on the K-1

On Schedule K-1, Line 13 is designated for deductions, each identified by a specific code. Code W represents certain deductible expenses, but they are not automatically subtracted from taxable income. Instead, they often require additional reporting on other tax forms or schedules.

The K-1 is issued by partnerships and S corporations to report each partner’s or shareholder’s share of income, deductions, and other tax-related items. In Part III, Line 13 lists deductions, with letter codes specifying the type. If Code W appears, it refers to specific expenses that may be deductible but require further analysis.

A supporting statement attached to the K-1 provides details on what the Code W amount represents. The IRS does not standardize a breakdown within the K-1 itself, making this statement essential. It may list categories such as unreimbursed partnership expenses or depreciation adjustments, which must be reviewed to determine their tax treatment.

Types of Expenses or Adjustments in Line 13W

Amounts reported under Code W often relate to deductions that require special treatment before they can reduce taxable income. These expenses typically include Section 754 depreciation adjustments, startup costs, and unreimbursed partnership expenses. Each has specific rules governing its deductibility.

A common item in this section is the Section 754 depreciation adjustment. When a partnership elects under Section 754 of the Internal Revenue Code to adjust the basis of its assets after a partner sells their interest, the resulting depreciation or amortization adjustments are passed through to individual partners. These adjustments may not be immediately deductible and often must be reported separately on Form 4797 or incorporated into the partner’s basis calculations.

Startup costs may also appear under Code W. These expenses, incurred when forming a partnership, are subject to capitalization and amortization rules under Section 195. Businesses can deduct up to $5,000 of startup expenses in the first year, with the remainder amortized over 15 years. If total startup costs exceed $50,000, the immediate deduction is reduced, and the remaining amount must be amortized over time.

Unreimbursed partnership expenses frequently appear under Code W. Unlike employee business expenses, which were largely eliminated as an itemized deduction under the Tax Cuts and Jobs Act of 2017, these expenses may still be deductible if the partnership agreement requires partners to cover certain costs personally. They must be reported on Schedule E rather than deducted directly on the K-1.

Relevance of Passive vs. Non-Passive Treatment

The IRS classifies business activities as either passive or non-passive under Section 469, affecting whether deductions can offset other income. This classification depends on the taxpayer’s level of participation in the business.

If a taxpayer does not materially participate—such as by working fewer than 500 hours in the business during the year—losses and deductions from that activity generally can only offset passive income. If there is no passive income to absorb the loss, the deduction is suspended and carried forward.

For those who materially participate, business deductions can usually offset other types of income, such as wages or investment earnings. The IRS provides multiple tests to determine material participation, including spending more than 100 hours in the activity if no one else participates more or being the sole decision-maker in significant business operations. Meeting these standards allows taxpayers to fully deduct eligible expenses in the current year rather than deferring them.

Calculation of Your Share

The portion of the Code W amount that applies to a taxpayer depends on how the partnership or S corporation allocates income and deductions. These entities do not pay tax at the corporate level; instead, they distribute income, deductions, and adjustments to partners or shareholders based on ownership percentage or specific allocation rules.

For partnerships, the governing document dictates how profits and losses, including deductions under Code W, are divided. Some partnerships allocate items based on capital contributions, while others use a formula considering factors such as services provided or special allocations under Section 704(b). If a partnership agreement includes a special allocation, the IRS requires that it have substantial economic effect, meaning it must reflect actual economic arrangements rather than being structured solely for tax benefits.

S corporations allocate deductions strictly based on ownership percentage. If an S corporation has three equal shareholders, each holding 33.33% of the stock, then deductions and adjustments, including those under Code W, are typically split in the same proportion. Unlike partnerships, S corporations cannot use special allocations, as all items must be distributed pro rata under Section 1366.

Reporting Requirements on Your Return

Once the Code W amount has been identified and allocated, the next step is determining where to report it on your tax return. These amounts often require separate forms or schedules to ensure proper categorization.

For individual taxpayers, deductible amounts from Code W are typically reported on Schedule E, Supplemental Income and Loss, which is used for income and deductions from partnerships and S corporations. If the expense qualifies as an unreimbursed partnership expense, it must be listed separately on Schedule E rather than included in the partnership’s reported net income.

If the deduction relates to amortization or depreciation adjustments, it may need to be reported on Form 4562, Depreciation and Amortization, before flowing through to Schedule E. If the deduction is subject to passive activity limitations, Form 8582, Passive Activity Loss Limitations, may be required to determine whether it can be used in the current year or must be carried forward.

Interactions with Other Schedule Items

Code W deductions often interact with other tax return items, influencing taxable income and potential tax liability. One key interaction is with the taxpayer’s basis in the partnership or S corporation. Deductions cannot reduce a taxpayer’s basis below zero, so any excess deductions may be suspended until additional basis is restored, such as through capital contributions or future income allocations.

Another interaction involves self-employment tax. While certain deductions reduce taxable income, they may not lower self-employment tax liability. For example, unreimbursed partnership expenses reduce a partner’s share of taxable income but do not directly reduce self-employment earnings unless properly reported.

Depreciation or amortization deductions from Code W may also affect the calculation of the Qualified Business Income (QBI) deduction under Section 199A, which allows eligible taxpayers to deduct up to 20% of qualified business income. Since QBI is based on net business income, adjustments from Code W could either increase or decrease the allowable deduction.