A partnership doesn’t pay federal income tax on its own earnings. Understanding how partnership tax works starts with one idea: the business files an informational return each year, and the income, losses, deductions, and credits pass through to the individual partners, who report their shares on their personal returns and pay the tax themselves. That structure avoids the double taxation corporations face, but it also puts the full weight of income tax, self-employment tax, and quarterly estimated payments on each partner directly.
Which Businesses Are Taxed as Partnerships
Several structures fall under partnership taxation. General partnerships form when two or more people run a business together and share liability. Limited partnerships pair general partners who manage and bear full liability with limited partners who invest capital and risk only what they contribute. Limited liability partnerships give all partners some protection from the professional mistakes of the others, which is why law and accounting firms often use them.
Multi-member LLCs are the most common entity taxed this way. The IRS automatically treats any LLC with two or more members as a partnership unless the owners file Form 8832 to elect corporate treatment.1Internal Revenue Service. Limited Liability Company – Possible Repercussions
One boundary worth knowing: a partnership whose interests trade on an established securities market is generally taxed as a corporation, not as a pass-through, unless 90% or more of its gross income comes from qualifying sources like interest, dividends, real property rents, or natural resource activities.2Office of the Law Revision Counsel. 26 USC 7704 – Certain Publicly Traded Partnerships Treated as Corporations
How Income Reaches Each Partner
Distributive Shares
Each partner’s slice of income and loss is called a distributive share. The partnership agreement sets how profits and losses split, and the splits don’t have to be equal. Any special allocation must have “substantial economic effect,” meaning the arrangement reflects real economic consequences rather than pure tax positioning.3Office of the Law Revision Counsel. 26 USC 704 – Partners Distributive Share If an allocation fails that test, the IRS reassigns income based on each partner’s actual economic interest.
Here is the point that catches new partners off guard. You owe tax on your distributive share whether or not the partnership actually hands you any cash. If the business earns $200,000 and reinvests all of it in equipment, each partner still pays tax on their share. The tax follows the allocation, not the check.
Guaranteed Payments
Some partners get fixed payments for services they provide or for the use of their capital, set without regard to whether the partnership turns a profit. These guaranteed payments behave more like salary than a profit share.4Office of the Law Revision Counsel. 26 US Code 707 – Transactions Between Partner and Partnership The partnership deducts them as a business expense, which reduces the ordinary income allocated to everyone. The receiving partner reports them as ordinary income and always owes self-employment tax on them. They show up in Box 4 of Schedule K-1. Distributive shares can include capital gains, qualified dividends, and other favorably taxed items; guaranteed payments cannot.
What the Partnership Files
Every partnership needs a federal Employer Identification Number before it starts operating.5Internal Revenue Service. Employer Identification Number Each year the partnership files Form 1065, an informational return reporting total income, deductions, and credits.6Internal Revenue Service. About Form 1065, US Return of Partnership Income Federal law requires the filing for every partnership, with a narrow exception for partnerships that had zero income, deductions, and credits during the year.7Office of the Law Revision Counsel. 26 US Code 6031 – Return of Partnership Income
Alongside the 1065, the partnership issues a Schedule K-1 to each partner. Certain items get broken out separately on the K-1 instead of being folded into ordinary business income: charitable contributions, Section 179 property deductions, and investment income all pass through individually because they hit different limits on each partner’s personal return.8Internal Revenue Service. Instructions for Form 4562 The IRS cross-references each 1065 against every partner’s individual return, so mismatches tend to generate notices quickly.
Deadlines and Extensions
Calendar-year partnerships must file Form 1065 by March 15.9Internal Revenue Service. Starting or Ending a Business 3 The earlier date gives partners time to receive their K-1s before the April 15 individual deadline. Form 7004 requests an automatic six-month extension to September 15.10Internal Revenue Service. About Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns That extension only covers the partnership’s return. It does nothing for the individual partners’ April 15 deadline.
Mandatory Electronic Filing
Beginning in 2024, partnerships that file 10 or more returns of any type during the tax year, counting income tax, employment tax, and information returns together, must file Form 1065 electronically.11Internal Revenue Service. Instructions for Form 1065 (2025) Once you add up Forms W-2, 1099, 1065, and K-1s, most partnerships with even a handful of employees or contractors cross the threshold. Paper filing remains available only below it.
What Each Partner Owes
Partners are treated as self-employed, not as employees. No W-2, no withholding at the business level.12Internal Revenue Service. Self-Employment Tax and Partners Each partner calculates self-employment tax on their own return using Schedule SE. The combined rate is 15.3%: 12.4% for Social Security and 2.9% for Medicare. For 2026, the Social Security portion applies only to the first $184,500 of self-employment income.13Social Security Administration. Contribution and Benefit Base Medicare has no cap.
General partners owe self-employment tax on their entire distributive share of ordinary business income. Limited partners get a break: federal law excludes a limited partner’s distributive share from self-employment tax, with one exception. Guaranteed payments a limited partner receives for services are still subject to it.14Office of the Law Revision Counsel. 26 USC 1402 – Definitions That distinction is one of the main reasons some owners prefer limited partnership structures.
Additional Medicare Tax
High-earning partners face an extra 0.9% Medicare tax on self-employment income above $200,000 for single filers or $250,000 for joint filers.15Internal Revenue Service. Questions and Answers for the Additional Medicare Tax It sits on top of the standard 2.9% rate. If a partner also earns wages elsewhere, wages and self-employment income combine to decide whether the threshold is crossed.
Quarterly Estimated Payments
Because nothing is withheld at the partnership, partners generally have to make quarterly estimated payments covering both income tax and self-employment tax. For the 2026 tax year, payments are due April 15, June 15, and September 15 of 2026, plus January 15 of 2027.16Internal Revenue Service. 2026 Form 1040-ES You generally need to pay estimates if you expect to owe at least $1,000 at filing and your other withholding won’t cover at least 90% of your current-year liability or 100% of last year’s.17Internal Revenue Service. Estimated Tax Missing the deadlines triggers underpayment penalties and interest, even if you pay the full balance in April.
Limits on Deducting Partnership Losses
Every partner has a basis in their partnership interest, essentially a running tally of after-tax investment in the business. Outside basis tracks the partner’s investment in their interest; inside basis refers to the partnership’s investment in its own assets.18Internal Revenue Service. Partners Outside Basis Basis goes up when a partner contributes money, when the partnership earns income, or when the partner takes on a share of partnership debt. It goes down with cash distributions, allocated losses, and debt paydowns.
Basis caps how much loss a partner can deduct. If basis hits zero, excess losses get suspended until the partner puts in more or the partnership generates income that rebuilds basis. Early-stage businesses that burn cash often push partners into this problem.
Basis is only the first of three hurdles. After the basis limit, the at-risk rules under Section 465 restrict deductions to amounts the partner actually has at financial risk, meaning cash contributed and amounts borrowed for which the partner is personally liable.19Office of the Law Revision Counsel. 26 USC 465 – Deductions Limited to Amount at Risk Nonrecourse loans, guarantees, and stop-loss arrangements don’t count. Losses blocked here carry forward.
Third come the passive activity loss rules. If you don’t materially participate in the business, your share of any loss is passive and can only offset other passive income, not wages or investment returns. Limited partners face a tougher standard: except in narrow circumstances, they are presumed not to materially participate, which makes their losses passive by default. The order is strict: basis, then at-risk, then passive.20Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules A loss that clears one hurdle can still be blocked by the next.
The Qualified Business Income Deduction
Partners in qualifying businesses can deduct up to 20% of their qualified business income under Section 199A, which reduces taxable income on the partner’s own return.21Internal Revenue Service. Qualified Business Income Deduction Originally set to expire after 2025, the deduction was made permanent by the One Big Beautiful Bill Act signed in July 2025.
The full 20% is available to partners whose taxable income stays below roughly $200,000 (single) or $400,000 (married filing jointly) in 2026. Above those thresholds, limitations phase in based on the W-2 wages the partnership pays and the value of its qualified property. Partners in specified service businesses like law, accounting, health care, and consulting face the steepest phase-out: once taxable income reaches roughly $275,000 (single) or $550,000 (joint), the deduction disappears entirely for those fields. Partners in non-service businesses can still claim a reduced deduction above the threshold if the partnership pays enough in wages or holds enough depreciable property.
The calculation gets complicated fast. Every partner should run the QBI numbers or have a preparer do it, because leaving 20% of qualified income unclaimed is one of the most expensive mistakes in partnership taxation.
Late Filing Penalties
A partnership that files Form 1065 late or leaves out required information faces a penalty of $255 per partner for each month or partial month the return is overdue, up to 12 months.22Internal Revenue Service. Failure to File Penalty For a five-partner business, that is $1,275 a month and can reach $15,300 over a full year. Larger partnerships face steeper consequences for the same delay.23Office of the Law Revision Counsel. 26 US Code 6698 – Failure to File Partnership Return The IRS can waive the penalty for reasonable cause, but forgetting or falling behind on bookkeeping doesn’t qualify.