A partnership itself pays no federal income tax. It tallies income and expenses on Form 1065, deducts what it can at the entity level, and passes each partner’s share through on Schedule K-1 for reporting on a personal return.1Internal Revenue Service. About Form 1065, U.S. Return of Partnership Income Partnership tax deductions therefore work on two levels: the business writes off ordinary operating costs, cost recovery on assets, and payments to partners before computing net income, and individual partners can then layer on the qualified business income deduction, retirement contributions, and a few partner-level items. Three separate loss limitations sit on top of all of it and can keep an allocated loss from ever reaching your 1040.
Operating Expenses the Partnership Writes Off
The partnership deducts standard operating costs on Form 1065 before any allocation to partners. The governing standard is the same one that applies to any trade or business: the expense must be ordinary and necessary.2Office of the Law Revision Counsel. 26 U.S. Code 162 – Trade or Business Expenses Rent, utilities, business insurance, office supplies, repairs, and advertising all qualify. Wages paid to W-2 employees who are not partners reduce partnership income directly.
Vehicle costs can be tracked actual-expense or claimed at the IRS standard mileage rate, which is 72.5 cents per mile for business driving in 2026.3Internal Revenue Service. IRS Sets Business Standard Mileage Rate A partnership that owns the vehicle must choose the standard rate in the first year the vehicle is used for business if it wants that option later; a leased vehicle on the standard rate must stay there for the whole lease.
Business interest is deductible, but partnerships whose average annual gross receipts exceed a threshold face a cap. The deduction generally cannot exceed business interest income plus 30% of adjusted taxable income.4Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Smaller partnerships below the gross receipts test are exempt. Any disallowed interest carries forward.
Everything in this bucket nets together into the partnership’s ordinary business income or loss, which is then split among partners under the partnership agreement.
Payments and Benefits Tied to Partners
Partners are not employees. The IRS treats a partner performing services in that capacity as self-employed, and the partnership cannot issue them a W-2.5Internal Revenue Service. Partnerships That status changes how partner compensation is deducted and what benefit write-offs are available.
Guaranteed Payments
A guaranteed payment is a fixed amount paid to a partner for services or the use of capital, owed whether or not the partnership turns a profit. A managing partner receiving $10,000 a month regardless of results is the classic example. The partnership deducts the payment as an operating expense on Form 1065, which lowers the ordinary income allocated to everyone. The receiving partner reports it as ordinary income in Box 4 of Schedule K-1, owes self-employment tax on it, and is taxed on it even if the cash is never distributed.
Partner Health Insurance
Partners generally cannot receive the tax-free fringe benefits available to regular employees. When the partnership pays a partner’s health insurance premium, the IRS treats the cost as a guaranteed payment. The partner includes the premium in taxable income and then claims the self-employed health insurance deduction on Form 1040, which offsets the income tax side. The partnership deducts the premium as an operating cost.
Partners also get an above-the-line deduction for half of the self-employment tax they pay. It does not reduce the self-employment tax itself, but it lowers adjusted gross income, which can matter for other income-based thresholds.
Unreimbursed Partner Expenses and Home Office
When a partner pays business costs out of pocket, the partnership agreement controls the outcome. If the agreement requires the partner to bear those costs without reimbursement, the expenses reduce the partner’s distributive share of income on Schedule E. If the agreement would have allowed reimbursement and the partner simply did not ask, no one gets to deduct them. The cleaner approach is almost always to submit an expense report, let the partnership reimburse and deduct the cost, and keep the reimbursement untaxed to the partner.
A home office follows the same rule. A partner using part of the home regularly and exclusively for partnership business can deduct the costs on Schedule E only if the partnership agreement expects the partner to maintain that office at their own expense. The space must also qualify as the partner’s principal place of business, meaning most income-earning work happens there or it is the primary location for administrative tasks with no other fixed office substantially used for that purpose.
Writing Off Equipment, Buildings, and Intangibles
Long-term assets cannot be deducted all at once under standard rules. The cost is recovered through depreciation, amortization, or an accelerated election, calculated by the partnership and allocated on Schedule K-1.
Depreciation and Bonus Depreciation
Tangible property with a useful life beyond one year is depreciated under the Modified Accelerated Cost Recovery System. Nonresidential buildings use straight-line depreciation over 39 years, residential rental property over 27.5 years. Equipment, vehicles, and furniture follow shorter schedules, often five or seven years, with the deduction front-loaded.
Bonus depreciation lets a partnership write off 100% of the cost of qualifying property in the year it is placed in service. The One Big Beautiful Bill Act permanently reinstated this full first-year write-off for eligible assets acquired after January 19, 2025. The partnership claims it on Form 4562, and the deduction flows through to each K-1.
Section 179 Expensing
Section 179 is a second path to an immediate deduction for qualifying equipment, machinery, and off-the-shelf software. Unlike bonus depreciation, it carries an annual dollar cap adjusted for inflation and a phase-out that shrinks the maximum deduction dollar-for-dollar once total property placed in service during the year exceeds a set amount. The partnership makes the election on Form 4562 and allocates the deduction on Schedule K-1.
One catch sits at the partner level: the Section 179 deduction a partner can actually use cannot exceed that partner’s taxable income from all active trades or businesses. Excess carries forward. Two partners in the same partnership can therefore end up with different usable amounts.
Intangibles, Startup, and Organizational Costs
Acquired intangible assets such as goodwill, trademarks, customer lists, and covenants not to compete are amortized evenly over 15 years from the month of acquisition.6Office of the Law Revision Counsel. 26 U.S. Code 197 – Amortization of Goodwill and Certain Other Intangibles7Internal Revenue Service. Intangibles
Startup and organizational costs get their own treatment. A partnership can elect to deduct up to $5,000 of startup costs and up to $5,000 of organizational costs in the year operations begin. Each $5,000 allowance phases out once the respective costs exceed $50,000. Anything not immediately deductible is amortized over 180 months starting with the month the business begins.
Three Hurdles Before You Can Deduct a Loss
An allocated loss on your K-1 is not an automatic deduction. Partners have to clear three tests in order, and a loss blocked at any stage is suspended and carried forward until the facts change. These rules exist to prevent writing off more than you actually have at stake.
Basis Limitation
First, the loss is measured against your outside basis in the partnership. Basis starts with cash and property you contributed and grows with your share of partnership income and partnership liabilities. Losses and distributions reduce it. Any allocated loss above your remaining basis at year-end is suspended indefinitely and becomes usable when basis later rises through contributions, income, or an increased share of partnership debt.
At-Risk Limitation
Even with enough basis, you can only deduct losses up to the amount you are personally at risk. That amount includes cash and property you contributed plus partnership debt for which you are personally liable. Most non-recourse debt does not count. The main exception is qualified non-recourse financing secured by real property, which does increase your at-risk amount. Losses blocked here are also suspended and released when your at-risk amount grows.
Passive Activity Loss Rules
The last test asks whether you materially participate in the partnership’s business. If you do not, the interest is passive, and losses can only offset income from other passive activities. They cannot offset wages, salary, or investment income. The most commonly used material participation test is the 500-hour test: participate for more than 500 hours during the tax year and you are a material participant.8Internal Revenue Service. IRS Tax Topic 425 – Passive Activities Losses and Credits Other tests cover lower-hour but still substantial involvement. Suspended passive losses carry forward indefinitely and become fully deductible when you dispose of your entire partnership interest in a taxable transaction.
The 20% Qualified Business Income Deduction
Eligible partners can deduct up to 20% of their share of the partnership’s net business income on their personal return.9Office of the Law Revision Counsel. 26 U.S. Code 199A – Qualified Business Income This deduction was originally set to expire after 2025 but has been made permanent. It is claimed from adjusted gross income on Form 1040, not at the partnership level.
QBI is the net amount of income, gain, deduction, and loss from the partnership’s trade or business.10Internal Revenue Service. Qualified Business Income Deduction Guaranteed payments for services, capital gains and losses, interest income not properly allocable to the business, and reasonable compensation to the partner are all excluded. The partnership reports each partner’s share of QBI, W-2 wages, and unadjusted basis of qualified property on Schedule K-1.
Below a statutory taxable income threshold (adjusted annually for inflation), the partner generally takes the full 20%. Above it, two caps phase in: the deduction cannot exceed the greater of 50% of W-2 wages the partnership paid that are allocable to the qualified business, or 25% of those W-2 wages plus 2.5% of the unadjusted basis of qualified property immediately after acquisition.9Office of the Law Revision Counsel. 26 U.S. Code 199A – Qualified Business Income A partnership with no employees and no significant tangible property can see partner QBI deductions fall to zero at higher income levels. Partners in specified service trades or businesses, such as law, accounting, health care, and consulting, face a steeper rule: their QBI deduction phases out entirely once taxable income passes the threshold and disappears at the top of the phase-in range.
Retirement Plan Contributions
Partners’ self-employed status opens up retirement plans that double as sizable deductions.
A SEP IRA allows contributions of up to 25% of a partner’s net self-employment income, capped at $72,000 for 2026. Net self-employment income for this calculation is the Schedule K-1 net profit reduced by the deductible portion of self-employment tax. The partnership can set up the SEP and contribute for each partner, or partners can contribute individually. The full contribution is deductible and lowers adjusted gross income.
A solo 401(k) fits partnerships whose only workers are the owners. For 2026, a partner can defer up to $24,500 in pre-tax or Roth elective deferrals, and the partnership can add up to 25% of the partner’s compensation as a profit-sharing contribution. The combined total cannot exceed $72,000. Partners aged 50 to 59 or 64 and older can add an $8,000 catch-up contribution, while those aged 60 to 63 can add up to $11,250 if the plan allows it.
Filing Deadline and Late Penalty
Form 1065 is due March 15 after the close of the tax year, or the next business day when that falls on a weekend or holiday. For the 2025 tax year the deadline is March 16, 2026. Form 7004 buys an automatic six-month extension to September 15, but that extends time to file, not time for individual partners to pay what they owe.
The late or incomplete filing penalty is assessed per partner for each month or partial month the return is overdue, for up to 12 months. It applies even if the partnership owes no tax, and it scales fast in a partnership with many partners. Getting Schedule K-1s to partners on time matters just as much, because no partner can file an accurate personal return without one.