A Small Business Guide to the Schedule K-1 Tax Form
Schedule K-1 shows how individuals report income from businesses they own. The Ascent explains how to complete and file the form.
You may have heard of the Schedule K-1 form if a banker asked for it or if your tax preparer asked for it. This is the small business owner’s version of the W2 form that you send to normal employees and the 1099 that you send to contractors.
The K-1 shows the amount of business taxes for the year that you must declare on your personal return as well as the evolution of your personal capital account in the company during the last year.
Read on to learn more about how K-1 is used and how to make your own.
Overview: What is the Schedule K-1 tax form?
The K-1 tax form is an additional form that helps small business owners file their personal taxes. The form shows income and other business information and you use it to complete your personal statement.
The form only applies to flow-through entities. Partnerships (which file as Form 1065) and S Corporations (IRS Form 1120) are the two business entities that pass income to owners to report on the personal return.
You may want to bookmark the Schedule K-1 instructions page on the IRS website, as the form changes every year.
K-1s are also used for trusts and estates. You may have experience with them if you have ever had money left in someone’s will. The figures are reported in the same appendix to the personal declaration.
Who must complete a K-1 form?
There is a two-part answer to this question. The business is required to complete the form and submit it to all owners of the business, and the owner is required to use the information to complete the personal statement and then file it officially.
How to Complete a Schedule K-1 Tax Form
Here are the steps to complete a K-1 form.
1. Complete the business tax return
Before you can start the K-1, use your tax software to complete the business tax return. The information you enter in the K-1 will come from the business statement.
Many intermediary companies will distribute the money necessary for the owners to pay the taxes. Be sure to keep the distributions and schedule M of the corporate return up to date, as you will need this information for the K-1.
2. Complete parts I and II of the form
In Parts I and II, the letters A to K need only be completed once and can then be carried over from year to year, except in the event of a change of ownership. Each of these items contains administrative information that you can find in the entity documents you have filed with your state, if you can’t remember them off the top of your head.
The L section is where it starts to get interesting.
The last two sections of Part II concern the contribution of property to the business as equity. If you did this and the property had an undeclared gain when assessed, check “yes” and report the amount of the gain.
3. Complete Part III of the form
Part III is where it starts to get tricky. Let’s go through it and talk about which sections may apply to your business.
- 1. Fill in the same first page number as you did in section L.
- 2.–3. Complete them if the business had rental property income.
- 4. Guaranteed payments are payments made to partners regardless of business income.
- 5.–10. These sections relate to income from various investments that the company has made that are not related to its business activities.
- 11. Other income the business earned that was not related to normal business activities. Specific IRS instructions contain codes to use for each type of income.
- 12.–13. Other expenses, including accelerated depreciation.
- 14. If you own the business with your spouse, you must declare and pay self-employment taxes.
- 15.–18. Less frequented sections. If you need to complete them, a related form will have been printed with your business statement.
- 19. Enter the result of Section L of Part II.
- 20. The instructions page above contains a list of what should be declared in the other information section.
4. Submit the form to the owners
When you send the final business tax return to the other owners, attach Schedule K-1 to the return.
5. File your personal tax returns
The most important figure for your return is net business income. This number will go in the Schedule E section of the personal statement.
Other items to track include capital gains to report on IRS Schedule D and distributions that will be of interest to your bank.
How do banks use K-1 forms?
Banks are primarily concerned with the debt service coverage ratio, which is usually calculated as follows:
(Free cash flow − Distributions) ÷ Debt service
The Small Business Administration requires a ratio of at least 1.15, and many banks will require a ratio even higher than that. The bank will pull the distribution number from the K-1 or Schedule M on the business statement and subtract it from the free cash flow.
It is subtracted because any money distributed outside the business is considered unavailable to pay off business debt.
Distributions can also help on business loans. If you own multiple businesses, the bank will take K-1s from each business and add the distributions to your personal income in its credit analysis.
It can be a balance between distributing enough revenue to make the investment worthwhile for the owners and making the banks happy with the company’s money.
A good practice is to set an amount that will be distributed each year (for example, half of net after-tax income) in the partnership agreement and stick to that figure. If the bank balks, you can indicate the agreement and show that you are not authorized to distribute any other amount.
When are K-1 forms due?
K1 returns are due to owners along with business tax returns on March 15 each year. If you are the sole owner of your business, the true due date is when you file your personal return by April 15.
File your tax return A OK-1
The world of small business taxes can seem like an endless mountain of paperwork with you acting like Sisyphus pushing paperwork over the hill to be eaten by IRS vultures at the end of the day.
The first step to feeling in control of your taxes and getting back to your business is understanding the information on each form. After reading this article, you should be able to either prepare your own K-1s or understand what your CPA has prepared and answer questions posed by your bankers.