Partnerships are taxed as pass-through entities: the business itself owes no federal income tax, and every dollar of profit, loss, deduction, and credit flows through to the individual partners, who report their share on their own returns. The partnership files an information return so the IRS knows who owes what, but the tax bill lands on the partners. Most general partners also owe self-employment tax on their share, and — this is the part that surprises new partners — you owe income tax on your allocated share even if the partnership keeps the cash and reinvests it.
How Pass-Through Taxation Actually Works
A partnership functions as a conduit. Its income and losses flow through to the partners, who report their individual shares on their personal returns. This avoids the double taxation that hits C corporations, where profits are taxed at the corporate level and again as dividends.
Each partner’s share is set by the partnership agreement. That share, called the distributive share, gets added to your other income for the year — wages, investments, other businesses — and the combined total determines your bracket and liability.
The trap: you owe tax on your distributive share whether or not the partnership hands you the money. If the partnership earns $200,000 and reinvests every dollar, a partner with a 50% share still owes income tax on $100,000. The IRS treats the economic benefit as yours the moment it is allocated, not when cash hits your account.
What the Partnership Files, and When You Get Your Numbers
Every partnership files Form 1065, the U.S. Return of Partnership Income, even though the entity owes no federal income tax. Section 6031 requires it: gross income, deductions, and each partner’s distributive share must be reported annually.1Office of the Law Revision Counsel. 26 USC 6031 – Return of Partnership Income
For calendar-year partnerships, Form 1065 is due March 15. A six-month extension is available on Form 7004, pushing the deadline to September 15.2Internal Revenue Service. About Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns
Filing late is expensive. Under Section 6698, the penalty is $195 per partner per month (or partial month) up to twelve months, adjusted for inflation each year.3Office of the Law Revision Counsel. 26 USC 6698 – Failure to File Partnership Return It applies even in a year the partnership earned nothing.
Reading Your Schedule K-1
After completing Form 1065, the partnership issues a Schedule K-1 to every partner. The K-1 breaks down your share of ordinary business income, interest, dividends, capital gains, rental income, deductions, and credits. Allocations must track the partnership agreement: a 30% partner sees 30% of each category.4Internal Revenue Service. Partners Instructions for Schedule K-1 Form 1065
Partners should receive their K-1 by March 15 for calendar-year partnerships. From there, you transfer the figures to the appropriate schedules on your Form 1040. Ordinary business income typically flows to Schedule E. Self-employment income goes to Schedule SE. Capital gains go to Schedule D. The K-1 is the roadmap for where each number lands.
Guaranteed Payments
Not everything on a K-1 works like a share of profits. Guaranteed payments are fixed amounts paid to a partner for services or for the use of their capital, determined without regard to whether the partnership turns a profit. A partner who runs day-to-day operations might receive $80,000 annually as a guaranteed payment regardless of results.
The partnership deducts guaranteed payments as a business expense; the receiving partner reports them as ordinary income.5eCFR. 26 CFR 1.707-1 – Transactions Between Partner and Partnership They also count as self-employment income. On the K-1 they appear in Boxes 4a (services), 4b (capital), and 4c (total).6Internal Revenue Service. Partners Instructions for Schedule K-1 Form 1065 If you receive both a guaranteed payment and a distributive share, you report both as ordinary income. Say the partnership earns $100,000 after paying you a $20,000 guaranteed payment, and you hold a 25% interest: you report $20,000 in guaranteed payments plus $20,000 as your share of the remaining $80,000.
Self-Employment Tax
Income tax is only half the story. General partners owe self-employment tax on their distributive share of partnership income, covering the Social Security and Medicare contributions an employer would otherwise split with a W-2 employee.7Internal Revenue Service. Entities 1 The combined rate is 15.3%: 12.4% for Social Security and 2.9% for Medicare.8Office of the Law Revision Counsel. 26 USC 1401 – Rate of Tax
The Social Security portion applies only up to the wage base, which is $184,500 for 2026.9Social Security Administration. Contribution and Benefit Base Earnings above that are still subject to the 2.9% Medicare tax, and high earners face an additional 0.9% Medicare surtax on self-employment income over $200,000 single or $250,000 joint. Partners report the tax on Schedule SE.
Limited partners get a break. Under Section 1402(a)(13), a limited partner’s distributive share is excluded from self-employment tax. The exclusion does not apply to guaranteed payments for services, which are always subject to self-employment tax regardless of partner status.10Internal Revenue Service. Self-Employment Tax and Partners One caveat: the IRS has never issued final regulations defining “limited partner” for these purposes, and the line between limited and general partners in modern LLCs remains genuinely unsettled.
Quarterly Estimated Tax Payments
Because no employer withholds taxes from partnership income, partners make quarterly estimated payments using Form 1040-ES. These payments cover both income tax and self-employment tax on expected partnership earnings for the year.11Internal Revenue Service. Form 1040-ES, Estimated Tax for Individuals
The 2026 deadlines:
- First quarter: April 15, 2026
- Second quarter: June 15, 2026
- Third quarter: September 15, 2026
- Fourth quarter: January 15, 2027
You can pay through the Electronic Federal Tax Payment System (EFTPS), IRS Direct Pay, or by mailing a check with the 1040-ES voucher.
Miss or undershoot a payment and the IRS charges an underpayment penalty based on the federal short-term interest rate plus three percentage points, compounded daily.12Internal Revenue Service. Quarterly Interest Rates You can generally avoid it if your payments cover at least 90% of the current year’s tax or 100% of last year’s tax (110% if your prior-year AGI exceeded $150,000).13Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty Partnership income fluctuates, so watching quarterly performance and adjusting mid-year is often the safer path.
Deducting Partnership Losses
Losses flow through the same way profits do, but deducting them is not automatic. The tax code imposes three separate hurdles, applied in order. Fail one and the loss carries forward.
Basis Limitation
You can deduct losses only up to your adjusted basis in the partnership interest.14Office of the Law Revision Counsel. 26 USC 704 – Partners Distributive Share Basis starts with what you contributed (cash or the adjusted basis of property), increases with your share of income, additional contributions, and your share of partnership liabilities, and decreases with distributions, losses, and nondeductible expenses.15eCFR. 26 CFR 1.705-1 – Determination of Basis of Partners Interest Losses over basis carry forward until basis recovers.
At-Risk Limitation
Even with sufficient basis, losses are further limited to the amount you have personally at risk: cash and property contributed plus any partnership debt you are personally liable for or have secured with personal assets.16Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk Nonrecourse debt generally does not increase your at-risk amount, with an exception for qualified nonrecourse financing in real estate. Blocked losses carry forward.
Passive Activity Limitation
The last hurdle applies if you do not materially participate in the business. Under Section 469, passive losses can offset only passive income, not wages, portfolio income, or active business income.17Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited For silent investors, this is often the binding constraint. Suspended passive losses carry forward indefinitely and release in full when you dispose of your entire interest in the activity.
The rules stack. A $50,000 loss might clear basis but get blocked at at-risk, or clear both and still be suspended as passive. Each limitation is tracked separately, and errors tend to surface on audit.
The Qualified Business Income Deduction
Section 199A lets non-corporate taxpayers deduct up to 20% of qualified business income from pass-through entities.18Office of the Law Revision Counsel. 26 USC 199A – Qualified Business Income The deduction is claimed on your individual return, not at the partnership level, and it reduces taxable income rather than AGI. For a partner with $100,000 in qualified business income, that can be up to $20,000 off taxable income.
The deduction was originally scheduled to expire after December 31, 2025 under the Tax Cuts and Jobs Act. Subsequent legislation extended it, though rules and thresholds may have shifted. For 2026, phase-out thresholds are expected to begin around $201,750 for single filers and $403,500 for joint filers. Below those, the full 20% is available. Above them, the deduction is reduced based on the W-2 wages the partnership pays and the unadjusted basis of its qualified property.
Partners in specified service businesses — law, accounting, health care, consulting, financial services — face additional restrictions and lose the deduction entirely once income exceeds the upper end of the phase-out. The math depends on figures reported on your K-1, so confirm the partnership included the supplemental information needed to compute the deduction.
State Pass-Through Entity Taxes
Most states tax partnership income at the individual level. A growing number now let partnerships pay state income tax at the entity level instead. These pass-through entity taxes (PTETs) were created as a workaround to the federal $10,000 SALT cap on individual state and local tax deductions.
The mechanism: the partnership elects to pay state income tax itself, and the IRS treats that payment as a deductible business expense at the entity level rather than an individual SALT payment subject to the cap. The IRS confirmed the treatment in Notice 2020-75.19Internal Revenue Service. Notice 2020-75 Partners then claim a credit on their state return for taxes the partnership paid, so they aren’t taxed twice at the state level.
Congress raised the SALT cap to $40,000 for 2025, with annual adjustments thereafter, which reduces the appeal of the workaround for many partnerships. In high-tax states where a partner’s share of state income taxes still exceeds the cap, the PTET election can produce meaningful federal savings. The election is generally made annually, and rules vary by state; not every state offers it, and those that do set different deadlines and procedures.