Creating a basic tax return for a Partnership is done in the Business Program of the Keystone Tax Solutions Pro software by following the steps below. To assist in your preparation of a 1065 return, you should review the Instructions for Form 1065 – US Return of Partnership Income. This publication contains line by line instructions detailing the transactions that need to be entered on each line of the 1065 return. A Partnership return has four basic areas that may need to be completed. Specifically, the preparer needs to address each of the following areas:
(1) Enter basic information about the Partnership into the return (Steps 1- 8);
(2) Enter the various income, deductions and items being distributed to the individual partners (Steps 9-15);
(3) Enter the information on the K-1 for the individual partners (Steps 16-22); and
(4) When applicable enter the Balance Sheet and reconcile Book Income (Loss) to the tax return (Steps 23-26).
Step 1 – Select ‘Business’ from the Main Menu of the tax program. Then select ‘Partnership Return’.
Step 2 – Enter the EIN of the Partnership and press the Enter key. A question will appear asking if you want to create a new return, select ‘YES’.
Step 3 – Form 1065 – Company Information Menu – Enter the partnership’s Name, Date Business Started and the Address for the partnership and then select ‘OK’.
Step 4 – Name & Address Menu – The partnership information that you have entered will be displayed in this menu. Enter the Name, Title and Contact Phone Number for the Partner Signing the Return of the partnership. This is the partner that is responsible for the filing of the tax return. This information is required and must be entered in order to electronically file the return. From this menu you may also enter an optional e-mail address for correspondence from the IRS to the partnership. Exit the menu to be taken to the Heading Information Menu.
Step 5 – Heading Information Menu
Total Assets – No manual entry is required in the Total Assets field. If the partnership has assets of at least $1 million or gross receipts of at least $250,000, you are required to complete a balance sheet (Schedule L) with the return. If the partnership is required to complete a balance sheet, you do not enter the Total Assets on this menu. Instead, the Total Assets will be pulled into this menu when you complete Schedule L in Step 22 below. If you are not required to complete a balance sheet (Schedule L), no entry is required on Line F of the Form 1065, which is the reporting of Total Assets.
Fiscal Year – If the partnership does not operate on a calendar year, enter the beginning and ending dates of their fiscal year. Since most partnerships operate on a calendar year, no entry would be made in this field for any calendar year reporting partnership. If a partnership has a short year because it started business in this calendar year, it would still operate as a Calendar Year entity if it’s year ends on December 31. Only fiscal year companies whose year ends on any other date than December 31 would make an entry in this Fiscal Year menu. Improperly entering dates may cause the return to reject because it’s tax reporting period on the return would be different than the IRS’ records.
Step 6 – Other Categories – In order to electronically file the return, you must enter a valid Business Code. Other important information includes the Principal Business Activity, Principal Product or Service and the Method of Accounting (Cash, Accrual or Other). Once you have completed this section and everything is correct, exit the Heading Information Menu and return to the Main Menu of the return (Form 1065).
Step 7 – Schedule B – From the main menu of the return (Form 1065), select Schedule B – Other Information. You should review and answer each of the questions found on Schedule B. The answers to the questions in this section will control what sections of the return you will ultimately need to complete.
Type of Entity – Several different types of entities can file a 1065 return, including domestic partnerships (both general and limited), foreign partnerships and domestic limited liability companies.
The remaining items in this menu should be reviewed for accuracy. The program has a default answer of ‘NO’ for most questions. Pay special attention to #6 Does This Partnership Meet All Four Requirements?,which defaults to ‘NO’. (In 2017 and prior years, this item was number 8.) However, if your partnership’s total receipts were less than $250,000 for the tax year AND the partnership’s total assets were less than $1 million at the end of the tax year, AND Schedule K-1’s are filed with the return and furnished to the partners on or before the due date (including extensions) AND the partnership is not filing or required to file Schedule M-3, you should change this to ‘YES’ and you will not have to complete Schedule L (Balance Sheet); Schedule M-1 (Reconciliation of Income) and Schedule M-2 (Analysis of Partner’s Capital Accounts).
Step 8 – From the Schedule B – Other Information Menu, select Additional Other Information. Review each question in this section to see if the defaulted answer is correct for the partnership. You must enter the Partnership Representative Information on this menu. The tax matters partner is the designated person in the partnership who receives tax notifications from the IRS, has the authority to enter in to tax agreements on behalf of the partnership and is responsible for keeping all partners informed of any applicable tax issues. Once you have completed this section and if everything is correct, exit back to the Main Menu of the tax return (Form 1065).
Note: In the following Steps 9-15, you will enter the Income, Deductions and certain Distributive Share Items that will be passed through to the respective partners on their K-1’s. You should skip any step in this section that is not applicable to the partnership and only complete those items that are necessary for the return.
Step 9 – Income – From the main menu of the return (Form 1065) select Income. Enter the appropriate trade or business activity income. Do not report rental income, portfolio income or other passive income items in this section. These items are distributive items that are allocated directly to the partners on Schedule K and will be entered later in the return. In this section you are entering the operating income of the partnership business activity. Many of the items entered in this section are similar to what an individual taxpayer would enter on a 1040, Schedule C. The income reported in this section may be subject to self-employment tax, which will be reviewed in Step 22.
Step 10 – Deductions – From the main menu of the tax return, Form 1065, select Deductions. Enter only trade or business activity deductions/expenses. Guaranteed Payments to Partners – If the partnership has operating income, enter any Guaranteed Payments made to partners for services to the partnership in this section. You should also include in this Guaranteed Payments’ entry any amounts paid by the partnership during the tax year for insurance that constitutes medical care for a partner, a partner’s spouse, a partner’s dependents, or a partner’s children under age 27 who aren’t dependents. If the partnership does not have any operating income or only has rental, portfolio or passive income, the Guaranteed Payments should be entered on Schedule K (Step 11) and not in this section. When you make an entry in Guaranteed Payments you will be asked if you would like to carry the amount entered to Schedule K. Generally, the answer to this question will be ‘YES’. However, the amount entered will not automatically carry to the individual partner’s K-1s. Such payments to the individual partners typically are not made in proportion to their ownership share. As a result, when you get to Step 21, you will need to allocate the amount of the Guaranteed Payments to the appropriate partner’s K-1’s.
As with the Income items entered in Step 9, you do not report any rental activity expenses, deductions allocable to portfolio income or non-deductible expenses in this section. Furthermore, if you do not have any activity income or expenses, then Lines 1– 22 of the 1065 will not have any entries on the form when the return is filed. Once you have entered all expenses and deductions related to the activity income, exit the menu.
Step 11 – Schedule K – From the main menu of the tax return, Form 1065, select Schedule K – Distributive Share Items. Select Income (Loss). Enter any income or loss for any Rental Real Estate Activities, as well as any portfolio activities such as Taxable Interest, Dividends, Royalties or Capital Gains that the partnership received. It is on this menu that you can enter Guaranteed Payments made to partners when the partnership does not have operating business activities. If you enter the Guaranteed Payments in this section, they will receive the same treatment on the partner’s individual tax return, but the payments will not be factored into the Ordinary Business Income (Loss) of the partnership. Regardless of where the Guarantee Payments are entered on the return, when you get to Step 21, you will allocate the amount of the Guaranteed Payments to the appropriate partner’s K-1’s. Once you have entered all income items, exit the Income (Loss) Menu and return to the Schedule K Menu.
Step 12 – From the Schedule K Menu, select Deductions. Enter certain deductions associated with the partnership that are given special treatment on the partner’s individual tax return. These types of deductions include Section 179 Expenses, Contributions and Investment Expenses. You will also need to review the entry items in the Other Deductions menu. Other deductions include Casualty/Theft Loss, Production Activities, W-2 wages, IRA’s, Dependent care benefits, Medical Insurance and other such items. Once you have entered all Other Deduction items, exit the Other Deduction Menu and return to the Schedule K Menu.
Step 13 – From the Schedule K Menu, review the items in the Credits Menu, Foreign Transactions Menu, and the Alternative Minimum Tax Menu (which include Depletion and Oil & Gas activities). Each of these sections of the Schedule K involve technical items in their respective areas that will be passed through to the individual partners on their K-1. You should refer to the Instructions for Form 1065 – US Return of Partnership Income for specific information on the items to be entered in this section.
Step 14 – From the Schedule K Menu, select Other. The items in this section will impact the basis of the individual partners in the partnership. It is in this section that you will enter tax exempt income and nondeductible expenses. You will also enter the total cash distributions to the partners and the fair market value of any property that is withdrawn or otherwise distributed to all of the partners.
Starting with the 2018 tax return, on this Schedule K – Other Menu you will access and enter all Section 199A information that is to be distributed to the partners on their respective Schedule K-1. By selecting Other Items & Amounts Reported Separately to Partners you will access the menu where all “Other” items are entered that will carry to Box 17 of the partners Schedule K-1. In this section you should enter the Qualified Business Income, the unadjusted basis of Qualified Property and any W-2 Wages paid by the partnership. Also any REIT dividends or Publicly Traded Partnership income (or loss received by the partnership) would be entered here. Once you have entered all these items select Exit to return to the Schedule K Menu. For additional information on making the Section 199A entries in Keystone Tax Solutions Pro see: Making QBID entries involving a Partnership (Form 1065)
Step 15 – At this stage of the return all of the income, deductions and credits for the partnership should have been entered in the return. Next, a K-1 must be entered for each partner in the partnership. Note that in the Schedule K Menu, the default setting for Automatically Distribute Schedule K Information is set to ‘YES’. This allows the program to distribute the items previously entered in the tax return to each partner’s K-1’s based on the criteria that you will enter in Step 16. If you choose to override this automatic distribution, you will need to select ‘NO’ and manually input the entries directly on each K-1.
Step 16 – From the Schedule K Menu, select Schedule K-1 Input and select ‘New’. Select the appropriate type of entity for the partner. Enter the Partner Information to include the SSN or EIN, Name and Address of the partner. You will also be required to enter the Partner Type. Select General Partner or LLC member-manager or Limited Partner or other LLC Member. Select ‘OK’.
Step 17 – Other Partner Information – Enter this partner’s Beginning Percentage of Profit Sharing, and this partner’s Ending Percentage of Profit Sharing. This process will be repeated for the Beginning and Ending Percentage of Loss Sharing and the Beginning and Ending Percentage of Capital. In many instances the ownership percentages will be the same at both the beginning and at the end of the year.
If there has been a change in ownership (or in the percentage of ownership), it can affect the allocation and distribution of income (loss) and other items. For this reason, you will also enter the Number of Days the Beginning Percentage of Ownership is to be applied to this partner. If the percentage remained the same for the entire tax year, enter 365 (even if this is an initial return and the business operated for less than 365 days). If the Partner’s Percentage of Ownership changed during the year, you will have to calculate the actual number of days that the Beginning Percentage of Ownership was in effect. These entries will determine how the automatic allocation will distribute income (loss) and other items to the partner’s K-1 and will allow the program to calculate the correct distribution of income, expenses and other distributions to the respective partners.
Also enter the beginning Capital Contributions for this partner. In this menu you also have the option to enter certain income, distributions and/or withdrawals, or you can enter these items later at Step 19. Once you exit this menu you will be at the individual partner’s K-1 menu which is where you will access this partner’s specific items.
Step 18 – Individual Partner’s K-1 Menu – Review the partner’s information, enter the partner’s basis information and make the adjustments (if necessary) to reflect any transactions by the partnership that were not handled by the automatic distribution features of the program. Other Information – In this menu, you can enter certain less common items that may occur when completing a 1065 return. These items involve Publicly Traded Partnerships, Foreign Partners and Nonrecourse/Qualified Recourse and Recourse Financing. If the K-1 is the final K-1 or an Amended K-1, it can be marked as such in the Other Information Menu.
Step 19 – Analysis of Partner’s Capital Account – The second section to review in the Individual Partner’s K-1 Menu is the Analysis of Partner’s Capital Account. Here you can make entries regarding this individual’s capital account or basis in the partnership. The beginning capital balance (which was entered in Step 17) will pull to this menu. Enter any additional capital contributions that the partner made during the year to the partnership, as well as any withdrawals that this partner took from the partnership. Also enter the Basis of Accounting that the partnership used to determine the partner’s Capital Account. The options for accounting basis include Tax Basis, GAAP, Section 704(b) book or Other. If you are not certain as to the accounting methodology being used, you should consult the Instruction for Form 1065 – US Return of Partnership Income.
Step 20 – Partner’s Adjusted Basis Worksheet – The third section to review in the individual partner’s K-1 menu is the Partner’s Adjusted Basis Worksheet. In this menu you can make entries regarding an individual partner’s basis in the partnership. This Basis Worksheet is given to the individual partner with the K-1 as a record of their basis in the partnership. Many items automatically pull to the worksheet; however you can enter any other items that increased or decreased this partner’s basis during the year.
Step 21 – Distributive Share Items – The next aspect of completing the K-1 is to review the distribution items for each partner. From the individual partner’s K-1 menu select Distributive Share Items. You should review each of the distributed items on the individual partner’s K-1. These items have been allocated to the partner automatically based on the percentage of ownership and profit (loss) that was entered earlier in Step 17, except for the Guaranteed Payments that this partner received. The program does not automatically allocate Guaranteed Payments based on the pre-selected percentages because in practice this is commonly allocated differently among the Partners than by their ownership percentages. Accordingly, you will have to enter the actual amount of Guaranteed Payments that each partner received by selecting from the Individual Partner’s K-1 Menu. Select Distributive Share Items, Income (Loss), Guaranteed Payments.
When you enter the Guaranteed Payments Menu, you will receive a prompt informing you that the Guaranteed Payments will carry to the Self-Employment Menu and you may need to adjust this amount on that Menu. For General Partners, Guaranteed Payments normally would not be adjusted on the Self-Employment Menu. However, for Limited Partners, Guaranteed Payments are generally treated as self-employment earnings only when the payments are for services they actually rendered to, or on behalf of, the partnership. As a result, it may be necessary to adjust the Guaranteed Payment amount on the Self-Employment Menu for some or all of the partners. If the Guaranteed Payment amounts that are pulled to the Self-Employment Menu need to be adjusted, see Step 22.
Step 22 – The final aspect of completing the individual’s K-1 is to review the Self-Employment Menu for each partner and make any appropriate adjustments. The program will automatically pull some items to the Self Employment Menu which are usually deemed self-employment earnings. For General Partners, the net earnings (loss) from self-employment that pulls to this menu includes their share of the partnership’s income (loss), but it does not include dividends and/or interest. These items (dividends and interest) usually are not considered self-employment income unless they are received in the course of a trade or business, such as a dealer in stocks or securities. Also for General Partners, rental income from real estate and royalty income is not normally included in their Self-Employment Income, (except when those items are received in the course of a trade or business) and do not automatically pull to the Self-Employment Menu. For a Limited Partner, their share of partnership income (loss) is not normally included in net earnings (loss) from self-employment and none of this income will automatically pull to the Self-Employment Menu.
Any adjustments to the income or loss to the Self-Employment Menu should be made by selecting from the Individual Partner’s K-1 Menu, Distributive Share Items, Self-Employment, Net Earnings (Loss) from Self-Employment, Adjustment to Net Earnings (+/-). For more information on what constitutes income (loss) for self-employment, see: Instructions for Schedule SE (Form 1040), Self-Employment Tax.
Steps 16-22 will be repeated for each partner until 100% of the ownership of the partnership has been allocated, as well as 100% of all distributive items have been accounted for on the K-1’s.
Steps 23 – 25 – Additional Forms and Schedules – If in Schedule B at Step 7, you answered ‘YES’ to the inquiry ‘Does This Partnership Meet All Four Requirements?’, you are NOT required to complete Schedule L. You should skip Steps 23-25 and proceed directly to Step 26. You do not have to complete Schedule L, Schedule M-1 and Schedule M-2, and you do not need to open any of those Menus to complete the return.Once these menus are opened, the program will automatically generate certain sections of the Schedules and you may not be able to delete the Schedule from the return.
If in Schedule B at Step 7 you answered ‘NO’ to the inquiry ‘Does This Partnership Meet All Four Requirements?’, you are required to complete Schedule L – Balance Sheet, and should proceed to Step 23.
Step 23– Schedule L – From the main menu of the 1065 Menu, select Schedule L – Balance Sheet. Select each asset corresponding to the partnership’s accounting records and enter the appropriate balances in each asset classification. These asset classifications match what the IRS is seeking on the Schedule L. For any assets that are classified as ‘Other Current’, ‘Other Investment’ or ‘Other Assets’ on the balance sheet, you will create a Supplemental Statement with a listing of those assets. The program will prompt you to create the Supplemental Statement when you make entries in these fields. The program will also automatically pull certain assets to the balance sheet if those assets have been entered in the Depreciation Module. See: Form 1065 – Schedule L – Balance Sheets per Books.
Step 24 – After you enter the assets for the partnership, enter the liabilities into the balance sheet. Select Total Liabilities & Capital from the Schedule L – Assets Menu. For any liabilities that are classified as ‘Other Current’ or ‘Other Liabilities’ on the balance sheet, you will create a Supplemental Statement with a listing of those liabilities. The program will prompt you to create the Supplemental Statement when you make entries in these fields. The program will also automatically pull certain Partner Capital positions into the equity portion of the Balance Sheet.
While working in the balance sheet, the program will provide a balance the bottom of the menu. The ‘Total Liability & Equity’, ‘Total Assets’ and the ‘Difference’ will be displayed to assist in getting the Balance Sheet to balance. Once you have completed this Menu, you should have a balance sheet that is in balance. Select Exit to return to the Main Menu of the tax return (Form 1065).
Step 25 – Schedule M-1 – Reconciliation – You must reconcile any differences between the book income (loss) of the partnership to the income (loss) being reported on the tax return. From the main menu of the tax return (Form 1065) select Schedule M-1 – Reconciliation. You should enter this menu to generate the Schedule even if no adjustments will be made. Adjust any items that are different from book income (loss) to the income (loss) on the tax return. The program will pull many of these items from other areas of the return. The most common item that may need adjustment is depreciation which may be different on the company’s books than on the tax return. This is primarily due to the practice of taking bonus depreciation on a tax return but using more conservative practices on the books of the company. A depreciation adjustment can either increase book income (loss) or decrease book income (loss). Once these entries have been completed, select Exit to return to the Main Menu of the tax return (Form 1065). See: Form 1065 – Schedule M-1 – Reconciliation of Income (Loss) per Books With Income (Loss) per Return.
Step 26 – Schedule M-2 – The final schedule that needs to be included on the tax return is Schedule M-2, Analysis of Partner’s Capital Accounts. From the Main Menu of the tax return (From 1065) select Schedule M-2. You should enter this menu to generate the Schedule even if no adjustments will be made. Adjustments which need to be made on this menu are very limited because the program will automatically pull most items to the Schedule M-2. See: Form 1065 – Schedule M-2 – Analysis of Partners’ Capital Accounts.
Step 27 – Mark Return Electronic – When all entries have been completed on the tax return, from the Main Menu of the tax return (Form 1065), select Mark Return Electronic if you want to e-file the return. If you have failed to enter certain required information the program will prompt you to correct the items before proceeding. Once you have successfully marked the return for e-file, you will be able to transmit the return from the Electronic Filing Menu which is accessed from the Business Main Menu after exiting the return. To exit the return press enter or select the exit button.
Step 28 – Receipt Menu – Select Exit from the main menu of the tax return (Form 1065). The Receipt Menu displays an overview of the calculated fees. You have the option to view and edit the invoice or enter a payment. When you exit the Receipt Menu you will be asked “Are You Ready to Mark the Return Complete?” Answer ‘NO’ if the return is not complete. Answer ‘YES’ to mark the return complete and exit back to the Main Business Menu.
NOTE: This is a guide on entering Form 1065 – US Return of Partnership Income into the tax tax program. This is not intended as tax advice.
Additional Resources:
Creating a Basic Form 1120 – U.S. Corporate Income Tax Return
Creating a Basic Form 1120S – U.S. Income Tax Return for S Corporations
Creating a Basic Form 1041 – U.S. Income Tax Return for Estates and Trusts