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  • Paul Carrano

What is a K-1 Federal Tax Form?

A K-1 is a tax document required by the Internal Revenue Service which applies to pass-through entities. Ok, but what is a pass-through entity? A pass-through entity is a business entity not subject to corporate tax. Instead of paying corporate tax, the income or loss is “passed through” to the owners or members, who are then taxed under their personal income tax. This avoids the same income becoming subject to double taxation.

Pass-through businesses include sole proprietorships, partnerships, limited liability companies, and S-corporations. Before the tax code changes in 1986, pass-through businesses made up less than half of all new businesses. As of 2015, excluding sole proprietors, which make up the vast majority of business returns, pass-through companies make up 80% of businesses. Including sole proprietors, these small businesses make up about half of all net business income. This is up from 22% in 1980.

Pass-through businesses do not pay taxes on income or earnings. As a pass-through, any income, including the taxes due on that income is shifted from the business to the stakeholders. The K-1 form reports each owner’s or participant’s share of the gains, losses, credits, and distributions. Confusion may come in that income doesn’t need actually to be distributed to be counted as a distribution.

A K-1 is similar to 1099 since it reports different types of income. The difference between the K-1 and 1099 is the investment made into a business. An employee receiving a 1099 may be a contract worker with no stake in the company. The person was hired as a contractor and has made no investment in the business. They are being paid for specific work being performed within a particular timeframe. A K-1 reports income. However, that income is based on an investment in a business. The person receiving the K-1 might not be doing any work for the company. However, due to their investment, they had a stake in the business and were entitled to a portion of the income or, conversely, responsible for any losses.

People eligible for a K-1 include

  • S corporation shareholders

  • Partners in limited liability corporations (LLCs), limited liability partnerships (LLPs), or other business partnerships.

  • Investors in limited partnerships (LPs) or master limited partnerships (MLPs)

  • Investors in certain exchange-traded funds (ETFs)

  • Trust or estate beneficiaries

K-2 and K-3s are new forms as of 2021. Schedule K-2 is called “Partners’ Distributive Share Items—International,” and Schedule K-3 is called the “Partner’s Share of Income, Deductions, Credits, etc.—International.” As the names denote, these new forms are related to “items of international tax relevance. Such items include:

  • Foreign tax credits

  • IRC §250 deductions with respect to foreign-derived intangible income

  • Inclusions of subpart F income and Global Intangible Low-Taxed Income

  • Distributions from a foreign corporation that are treated as dividends or excluded from gross income because they are attributable to previously taxed earnings and profits

These new forms provide more detail on income related to foreign business entities previously included in a single line on the Schedule K and K-1. The new forms are meant to standardize how international income is reported for pass-through businesses, provide clarity for partners and members when filing their personal taxes, and better assess compliance.

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