Schedule K-1 - Explained
What is a K-1?
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Table of ContentsWhat is a Schedule K-1?How is a Schedule K-1 Used? Factoring in Partnership AgreementsBasis CalculationIncome ReportingAcademic Research on Schedule K-1
What is a Schedule K-1?
A Schedule K-1 refers to a tax form that businesses partners use to report their partnership earnings or income, losses, dividends and credits. A schedule K-1 is a tax document that the Internal Revenue Service (IRS) requires business partners to file for tax purposes. The tax document is prepared to report each partners share of the earnings and losses associated with the partnership. This means that the report is made to capture each individual partner.
How is a Schedule K-1 Used?
There are diverse tax forms or documents that taxpayers use in filing tax reports with the Internal Revenue Service. These tax forms vary and have different uses. The Schedule K-1 is a tax form used by the IRS, individual partners in a business entity or partnership are required to report their share of the partnerships earnings, losses and dividends. The Schedule K-1 tax documents moves the tax liability of a business entity or corporation to individuals who make up the partnership. All the financial report for each individual partner contained in Schedule K-1 is submitted with Form 1065 when filing with the IRS. Form 1065 is the report of the partnerships transactions. The income realized by each partner is added to their personal income and recorded in Form 1040.
Factoring in Partnership Agreements
In every partnership agreement, there are two or more people who come together and agree to do business as partners. The partnership agreements are contained in the contract. This contract also contains the rules of the partnership, the obligations of each of the partners and how losses, income and dividends will be distributed to the partners. In limited partnership, the amount of capital that each partner contributes to determine the level of debts and obligations they undertake. Also, in a partnership, there is a general partner (GP) who is the partner in charge of operations. The GP gives accounts for the outcomes of the actions and activities of other individuals in the partnership.
When calculating the losses, earnings and dividends of each partner in a business partnership, it is vital to keep track of the investmnet of the partner in the partnership. The investmnet of partners in the partnership is referred to as the basis in the partnership. A partners investmnet in a partnership is affected by losses or debt obligations and also increased by income (earnings) or capital contributions. Also, if partners make withdrawals from an investment, the partners basis in the partnership reduces. It is important to know that the calculation of each partners basis is crucial when reporting on Schedule K-1.
One of the major reporting on schedule K-1 is the income reporting which can be categorized into different sections. The different types of income reported on Schedule K-1 are;
- The guaranteed payments partners earn through their investment in the partnership.
- Rental income for the real estate holdings of the partnership.
- Interest payment of securities such as stocks and bonds.
- Royalty income and others.
These categories of income are reported on the Schedule K-1 for each partner.
Academic Research on Schedule K-1
- Closing the gap: automated screening of tax returns to identify egregious tax shelters, DeBarr, D., & Eyler-Walker, Z. (2006). ACM SIGKDD Explorations Newsletter, 8(1), 11-16. As per the latest strategic plan for the US Internal Revenue Service, high-income persons are the main contributor to the tax gap, which is the difference between the tax amount that should be collected and the one that is collected in actual. This paper highlights the statistical analysis and machine learning use to help these persons involving in abusive tax shelters. Analysis of known abuse on the basis of Kernel allows targeting these taxpayers whereas associative analysis allows taxpayers targeted groups engaging in a tax shelter, a general financial adviser is promoting. The analysis requires risk, a weighted collection of potential income loss and the abuse.
- Tax incidence under oligopoly: a comparison of policy approaches, Hamilton, S. F. (1999). Journal of Public Economics, 71(2), 233-245. This study proposes a methodology analyzing the tax incidence encompassing known types of taxation in a common and analytically easy model. The tax performance is subject to the unit tax rate sensitivity to changes in the output of the industry in oligopolistic industries. Tax schedules with output elasticity tend to be over-shifted and contain superior welfare characteristics in relation to regulatory instruments responding less to the equilibrium market quantity. For tax reforms of revenue neutrality, the findings are that the ad valorem taxes welfare-dominating certain taxes in an oligopoly are taken as a particular case of the general result.
- Business in the United States: Who Owns It, and How Much Tax Do They Pay?, Cooper, M., McClelland, J., Pearce, J., Prisinzano, R., Sullivan, J., Yagan, D., ... & Zwick, E. (2016). Tax Policy and the Economy, 30(1), 91-128. This paper collects admin tax data from the year 2011 to specify pass-through business owners and calculate the amount of tax paid by them. The authors find 3 results: (a) Income of pass-through business concentrates substantially among high-earners. (b) There is opaque partnership ownership. Unclassifiable partners get twenty percent income while circularly owned partnerships earn fifteen percent income. (c) The rate of federal income tax on United States pass-through income is nineteen percent on average which is very low as compared to that of traditional corporations. If pass-through activity stays at a low level like the 1980s, US tax rate on overall business income of US on average will be twenty-eight percent instead of twenty-four percent.
- Consistent estimation of the impact of tax deductibility on the level of charitable contributions, Reece, W. S., & Zieschang, K. D. (1985). Econometrica: Journal of the Econometric Society, 271-293. If the income tax schedule is taken as a progressive step function, the contribution marginal price generally becomes an increasing step function of the level of the contributions. The spurious correlation between the observed marginal price and contributions level complicates the issue of calculating a function of contributions demand for individuals. The authors consider this econometric issue in calculating a demand function for contributions using 1972 to 1983 data collected in the Consumer Expenditure Survey. The authors provide evidence on the effects of alternative tax strategies on charitable giving with the help of model parameters estimation.
- Estimating tax noncompliance with evidence from unaudited tax returns, Feldman, N. E., & Slemrod, J. (2007). The Economic Journal, 117(518), 327-352. This paper estimates the tax noncompliance degree with the help of evidence from unaudited tax returns. The authors derive the noncompliance measurements from the relation between reported salary income and charitable contributions than alternative reported sources of income, for example, farm, employment and income of the small business. Supposing that a persons income source has no relation to his charitable inclinations and the ratio of real income and taxable income does not change by the source of income. Any difference in these relationships can be credited to underreporting by the person. The findings are that the noncompliance implied amount is important and that it changes with the income source.
- Effects of tax depreciation policy and investment incentives on optimal equipment replacement decisions, Chisholm, A. H. (1974). American Journal of Agricultural Economics, 56(4), 776-783. The research analyzes the impacts of income tax policy, using a model, on the replacement optimal timing for farm equipment. The author finds the effect of some tax investment incentives forms on the best replacement age to be substantial whereas the impact of various models of tax depreciation techniques is minimal.
- Measuring income tax discrimination, Kakwani, N. C., & Lambert, P. J. (1999). Review of Economics and Statistics, 81(1), 27-31. This paper presents a procedure to measure the systematic discrimination effect on the income tax. The authors assume various socioeconomic groups to encounter various tax schedules. The study depicts that the schedules group speciality causes a welfare loss, where the dollar value is the discrimination measure. Introducing vertical equity being the dollar value of the welfare superiority of tax system over the same yield flat tax, discrimination becomes equal to vertical equity loss. The authors find the Australian Income tax discriminating against salary and wage earners leading to roughly one percent loss, in 1984, of social welfare.
- The elasticity of the US individual income tax: its calculation, determinants and behavior, Fries, A., Hutton, J. P., & Lambert, P. J. (1982). The Review of Economics and Statistics, 147-151. This research examines the elasticity of the United States individual income tax. The authors focus on how to calculate it, what are the determinants of this tax and the behaviour of taxpayers toward this kind of taxation. The method used by the authors is simple and makes the optimal use of available data. It comes without any untestable assumptions and generates value every year for the overall income tax liabilities point elasticity. The findings are that the elasticity is much higher as compared to the assumed one and we can identify the impacts of many discretionary changes in the taxation system, such as Tax Reforms Act 1964 and 1969.
- Voting over nonlinear income tax schedules, Rell, A. (1996). unpublished paper. This research is based on a positive theory of NIT (Non-Linear Income Taxation). Every society member has a schedule of the most preferred income tax, given his ability, which maximizes his utility depending on the incentive and revenue constraints. These tax schedules are featured and show a high tendency to rate of marginal tax which rises with income than the tax schedules determined in the original position. There are given conditions under which preferences of agents are single-peaked over these tax schedules so that most of the people voting this limited class enact the desires of the median voter.
- Pareto efficient tax structures, Brito, D. L., Hamilton, J. H., Slutsky, S. M., & Stiglitz, J. E. (1990). (No. w3288). National Bureau of Economic Research. There are restrictive technical assumptions of a number of optimal income taxation analyses on preferences, for example, single-crossing and derive features of welfare maximizing schedules of tax only. This paper elaborates efficient tax structures of Pareto for an economy having a finite number of commodities and groups supposing monotonicity and continuity of preferences. Most outcomes follow from a self-selection property directly. At an optimum, a group envies another groups bundle that makes payment of a larger total tax. The groups bundle making payment of the largest overall tax is undistorted. The authors also state the tax framework at distorted outcomes.