Are you a partial or whole owner of an
S corporation, a partner in a business, or a beneficiary of a trust?
Then you may have learned that your income tax filing must include a
Schedule K-1. This is an unfamiliar form to most American taxpayers,
so it may sound confusing. To help clear up any questions you have
about this key business income tax form, here is a brief guide to the
K-1.
Who Must Create a Schedule K-1?
Schedule K-1 is part of the business
tax filing requirements for most pass-through entities. A passthrough
entity is a business structure in which income and expenses are
passed through to the owners to declare on their personal income tax
returns. The owners also pay income tax due based on income and
expenses.
The most common pass-through entities
are partnerships, S corporations, and limited liability companies.
Less commonly, trusts fall into this category even if they are not a
typical business.
When a pass-through entity earns income
and pays expenses, then, it must proportion out the amount
attributable to each shareholder, partner, or beneficiary and report
this information to them. A Schedule K-1 is how the business does
this. This document must be prepared by the business and provided to
relevant parties by the due date of the business tax return.
Why Is Schedule K-1 Necessary?
You may ask why you can't simply use
the company's accounting books as a base and do the math of how much
your portion of profit is. The answer is that the company's books and
its income tax returns may end up looking quite different from one
another. That's because what is allowable for tax purposes may be
different than what is allowable under standard accounting practice.
For instance, depreciation for tax
purposes is taken on a set IRS schedule based on the asset, its life
expectancy, and any special depreciation claimed. However, on the
books, your company may find that it's better to continue using
standard depreciation for financial statements. Using two different
methods is acceptable practice and has benefits for each purpose. But
it will change the tax form's bottom line.
Should You File a Schedule K-1
on Your Own?
Understandably, many small businesses
on a tight budget would rather create a Schedule K-1 in-house to save
money. But is this a good idea? Generally, it's not. Here are two
reasons why that is usually true.
First, the K-1 can be a complicated
form to understand and report correctly. In a partnership, for
example, it must include information about the partners' capital
account balances, their share of Section 179 depreciation, short- and
long-term capital gains, and relevant business credits. Since an S
Corporation can have up to 100 shareholders, correctly proportioning
all these elements can take a lot of work.
Second, because the K-1 affects the
taxes of shareholders or partners, a single error on this form could
have far reaching and expensive consequences. If the business fails
to properly calculate which items are tax-exempt or nondeductible and
then report this wrong information, shareholders could end up paying
higher or lower personal taxes than they should. That may attract the
attention of the IRS or state tax agencies.
Where Should You Start?
If your business or trust needs to file
a Schedule K-1, begin by consulting with an experienced accounting
and bookkeeping service. Quality
Bookkeeping Services Inc.
can help. Our team includes
professionals qualified to assist with everything from routine
bookkeeping data entry to preparation of company tax forms to how
your personal taxes will be affected. Call today to make an
appointment.
