How Does a K-1 Affect Your Taxes: Income, Deductions, and QBI

A Schedule K-1 affects your taxes by adding your share of a pass-through entity’s income, deductions, and credits directly to your personal return, where the income is taxed at your ordinary rates of 10% to 37% for 2026. The entity itself pays no income tax on those profits. You do, even in years when no cash is distributed to you. Depending on the entity type and your role, that same K-1 income can also pull in self-employment tax, the 3.8% net investment income tax, or a 20% qualified business income deduction that softens the hit.

Where a K-1 Comes From

Three kinds of pass-through entities issue K-1s: partnerships (Form 1065)¹, S corporations (Form 1120-S)², and trusts or estates (Form 1041)³. Each reports its total earnings to the IRS but shifts the tax bill to owners or beneficiaries. Your reporting obligation is the same whether you run the business day to day or own a passive minority stake.⁴

How the Income Gets Taxed on Your Return

K-1 income stacks on top of your wages, interest, and other earnings. Because federal brackets are progressive, the added income is taxed at whatever marginal rate your total income reaches. For a single filer in 2026, the brackets run from 10% on income up to $12,400 through 37% above $640,600; the 37% bracket for married couples filing jointly starts at $768,700.⁵ If you earn $80,000 at a job and receive a K-1 with $40,000 of ordinary business income, that K-1 amount lands in your 22% and 24% brackets.

Not every dollar on a K-1 is ordinary income, and the character matters. Box 1 of a partnership K-1 reports ordinary business income; Box 2 reports rental real estate income or loss; Boxes 5 through 9b cover portfolio items like interest, dividends, royalties, and capital gains.⁶ Qualified dividends and long-term capital gains keep their preferential rates of 0%, 15%, or 20% when they flow to you. Deductions and credits the entity passes through, such as Section 179 equipment expensing (up to $2,560,000 for 2026), charitable contributions, and foreign tax credits, ride along in their own boxes and reduce what you ultimately owe.⁷

Phantom Income: Tax on Money You Didn’t Receive

This is the single biggest surprise for new K-1 recipients. If the entity earns profits but reinvests them rather than distributing cash, you still owe tax on your allocated share.⁶ The IRS looks at what was allocated to you on paper, not what hit your bank account. A profitable partnership that makes no distributions can leave you writing a large check in April for income you never touched. The practical defense is asking the entity early in the year whether it plans to distribute enough cash to cover the tax on allocated income.

Self-Employment Tax Depends on the Entity

Self-employment (SE) tax covers Social Security and Medicare at 15.3% on the first $184,500 of net SE income for 2026, then 2.9% Medicare above that wage base, plus an additional 0.9% Medicare surtax once SE income exceeds $200,000 for single filers or $250,000 for joint filers.⁸⁹ Whether your K-1 income triggers any of it depends on the entity and your role:

General partners owe SE tax on their share of ordinary business income, reported in Box 14, Code A.
Limited partners are generally exempt on their share of partnership income, except for guaranteed payments for services.
S corporation shareholders owe no SE tax on K-1 income. The trade-off is that shareholders who work in the business must pay themselves a reasonable W-2 salary, which carries payroll taxes.

The gap is real. A general partner with $100,000 of K-1 income faces roughly $15,300 of SE tax on top of income tax. An S-corp shareholder with the same $100,000 of K-1 income pays nothing in SE tax on that figure, though the reasonable-salary requirement sits alongside it.

Deductions and Loss Limits That Shape the Final Bill

The 20% Qualified Business Income Deduction

If your K-1 shows ordinary income from a qualifying trade or business, you may deduct up to 20% of that income under Section 199A before calculating tax. The One Big Beautiful Bill Act made the deduction permanent.⁵ For 2026, the deduction is generally straightforward if your taxable income stays under $201,750 ($403,500 for married filing jointly). Above those thresholds, the deduction begins phasing in limitations based on the business’s W-2 wages and depreciable property. The phase-in range runs up to $276,750 for most filers and $553,500 for joint filers. Specified service businesses, including health care, law, accounting, consulting, and financial services, lose the deduction entirely above the phase-in ceiling.¹⁰

Basis Limits How Much Loss You Can Actually Take

A K-1 loss doesn’t automatically become a deduction. Partnership K-1s include a capital account summary (Item L), and S-corp shareholders file Form 7203 to track stock and debt basis.¹¹ Your basis is essentially what you have economically invested. It rises with contributions and allocated income, and falls with distributions and losses. If you claim losses beyond your basis, the IRS will disallow the excess. If a distribution exceeds your basis, the overage becomes a taxable capital gain. Keeping an accurate running basis figure is your responsibility, not the entity’s.⁷

Passive Activity Rules

If you don’t materially participate in the business, the K-1 income and losses are passive, and passive losses can only offset passive income.¹² You cannot use a passive loss from a partnership investment to shelter wages or portfolio income. Unused losses carry forward until you produce passive income to absorb them or dispose of your entire interest. Losses also require you to file Form 8582 to calculate what the IRS will actually allow.¹³

Rental activities are automatically passive with one important carve-out: if you actively participate in a rental real estate activity and own at least 10% of it, you can deduct up to $25,000 of rental losses against nonpassive income each year. That allowance phases out between $100,000 and $150,000 of modified adjusted gross income. Limited partners don’t qualify.¹⁴

At-Risk Rules

Before the passive rules even come into play, losses are capped by the amount you have at risk in the activity. You’re at risk for cash you contributed, amounts you borrowed and are personally liable for, and certain qualified nonrecourse real estate financing. You’re not at risk for amounts protected by guarantees, stop-loss agreements, or nonrecourse loans with no personal exposure.¹⁵ Losses beyond the at-risk amount suspend and wait for a year when your at-risk basis grows.

The 3.8% Net Investment Income Tax

Passive K-1 income can trigger an additional 3.8% net investment income tax if your modified adjusted gross income tops $200,000 (single), $250,000 (joint), or $125,000 (married filing separately).¹⁶ The tax applies to the lesser of your net investment income or the amount your MAGI exceeds the threshold. Income from a business you materially participate in is not subject to NIIT. The same K-1 income can be exempt or hit with the 3.8% surtax depending on whether you clear the material participation tests.

Cash Flow: Estimated Payments and Late K-1s

K-1 income has no withholding. If you expect to owe more than $1,000 at filing time, you generally need to make quarterly estimated payments.¹⁷ The 2026 due dates are April 15, June 15, September 15, and January 15, 2027. To avoid underpayment penalties, pay in at least 90% of your 2026 liability or 100% of your 2025 liability, whichever is smaller. If your 2025 AGI topped $150,000, that second figure becomes 110%. The IRS currently charges 7% annual interest on underpayments, compounded daily.¹⁸

Partnerships and S corporations owe you a K-1 by March 16 for calendar-year entities, but many file extensions and send the form months later.¹⁹ That is why so many K-1 recipients file their own extensions using Form 4868, which pushes the return deadline to October 15. The extension covers filing only. You still need to estimate and pay any tax owed by April 15 to avoid interest and penalties.

K-1s Can Create State Tax Bills Too

If the entity operates in states beyond where you live, you may owe tax in each of them. Most states with an income tax require nonresidents to file and pay on income sourced within their borders, including a share of a partnership or S-corp doing business there. An entity operating across five states can produce five nonresident filings for each owner, on top of your resident return.

Your home state usually gives a credit for tax paid to other states on the same income, which prevents full double taxation but doesn’t always make you whole when another state’s rate is higher. Some states have enacted pass-through entity tax elections that let the entity pay state tax at the entity level, generating a federal deduction that sidesteps the $10,000 individual SALT cap. Whether your entity has made a PTET election is worth confirming, because it changes both your state credit math and your federal deduction.

Publicly Traded Partnerships Follow Stricter Rules

If your K-1 came from a publicly traded partnership, such as a master limited partnership held in a brokerage account, the passive activity rules tighten. Losses from a PTP can only offset income from that same PTP, not from other PTPs and not from other passive activities.⁶ Suspended losses wait until that PTP produces income or you dispose of your entire interest in a taxable sale to an unrelated party, at which point all previously suspended losses become deductible.

1
Internal Revenue Service. About Form 1065, U.S. Return of Partnership Income
2
Internal Revenue Service. Shareholder’s Instructions for Schedule K-1 (Form 1120-S)
3
Internal Revenue Service. 2025 Instructions for Form 1041
4
Internal Revenue Service. Instructions for Form 1065 (2025)
5
Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026
6
Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065)
7
Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065) (2025)
8
Office of the Law Revision Counsel. 26 USC 1401
9
Social Security Administration. Contribution and Benefit Base
10
eCFR. 26 CFR 1.199A-5
11
Internal Revenue Service. About Form 7203
12
Office of the Law Revision Counsel. 26 U.S. Code 469
13
Internal Revenue Service. Instructions for Form 8582 (2025)
14
Internal Revenue Service. Publication 925 (2025)
15
Office of the Law Revision Counsel. 26 USC 465
16
Internal Revenue Service. Topic No. 559, Net Investment Income Tax
17
Internal Revenue Service. 2026 Form 1040-ES
18
Internal Revenue Service. Interest Rates for the First Quarter of 2026
19
Internal Revenue Service. First Quarter Tax Calendar