We discussed yesterday how information flows from a partnership or S corporation to your 1040 via the Schedule K-1. Unfortunately, as elaborate as the K-1 is, it doesn't necessarily have all of the information you need.
When the K-1 shows nothing but income items, reporting the information is usually simple. When the K-1 shows losses, things can get complicated.
There are three limits that apply to the use of K-1 losses, applied in the following order:
1. You can't deduct losses in excess of your basis.
2. Even if you have basis to deduct losses, the basis has to be "at-risk," and
3. Even if the basis is "at-risk," losses that are "passive" might be limited.
Neither the 1065 (partnership) or 1120-S (S corporation) K-1s are well designed to tell you what your basis is. The taxpayer or the tax preparer for the K-1 have to do that, year-by-year.
COMPONENTS OF BASIS
- Your basis starts with your initial investment in your ownership interest.
-It is increased by taxable income and deductible expenses, as reported in lines 1-12 of the 1120-S K-1, or lines 1-13 of the 1065 K-1.
-It is increased by tax-exempt income (like municipal bond income) and reduced by permanently non-deductible expenses (like the 50% non-deductible portion of meals and entertainment expenses); these are reported on line 16 of the 1120S K-1 and line 18 of the 1065 K-1.
- It is increased by capital contributions, which appear nowhere on the 1120S K-1 and on Part I, line L of the 1065 K-1.
- It is reduced by distributions, which are on line 16 of the 1120-S K-1 and Line 18 of the 1065 K-1.
excerpt form 2007 Form 1065 K-1
You can also get basis for losses in an S corporation by making direct loans to the corporation. Nothing on the S corporation K-1 tells you how much basis you have from loans.
Partners - unlike S corporation owners - can also get basis from loans to the partnership by third parties. This information shows up in Part II, Line K of the 1065 K-1.
Sometimes, depending on how the partnership K-1 is prepared, you can combine your share of debt with your "ending capital account" on Line L, part II, of the K-1 to determine your basis. This usually only is possible in a simple partnership that has the line L "tax basis" box checked. Otherwise, you need to track your own basis on the side.
Next: Are you "at-risk"?
This is part of our daily series of 2008 filing-season tips that we are running through April 15.
The items included in the Tax Update Blog are informational only and are not meant as tax advice. Consult with your tax advisor to determine how any item applies to your situation.
Joe Kristan writes the Tax Update items, and any opinions expressed or implied are not necessarily shared by anyone else at Roth & Company, P.C. Address questions or comments on Tax Updates to