A limited partnership doesn’t pay federal income tax on its own earnings. Instead, limited partnership tax reporting works on a pass-through model: the partnership files Form 1065 as an information return, issues each partner a Schedule K-1 showing their allocated share of income, deductions, and credits, and the partners then report those amounts on their personal returns. Getting the entity-level filing right is what makes the partner-level filings possible, because every K-1 number depends on the 1065.
Pass-Through Taxation in Practice
The IRS treats a limited partnership as a conduit rather than a separate taxpayer.1Internal Revenue Service. Partnerships Income and deductions are computed at the entity level, then flow through to the partners in the proportions set by the partnership agreement. The same dollar is not taxed once at the entity and again when distributed.
One consequence catches new limited partners off guard every year: you owe tax on your allocated share whether or not the partnership sends you any cash. If the partnership earned $200,000 and your K-1 shows $50,000 as your share, that $50,000 goes on your return even if you received nothing. Some partnerships make small “tax distributions” to help partners cover the liability, but they are not required to.
Form 1065: What the Partnership Files
The partnership files Form 1065, reporting gross income, deductions, and the resulting net profit or loss for the year.2Internal Revenue Service. About Form 1065, U.S. Return of Partnership Income The form doesn’t produce a tax bill for the entity. It tells the IRS what happened financially and provides the raw material for every partner’s K-1. Form 1065 uses the partnership’s own Employer Identification Number.
Since 2020, partnerships have been required to report each partner’s capital account using the tax basis method under a transactional approach.3Internal Revenue Service. IRS Notice 2021-13 That means tracking contributions, share of income or loss, distributions, and other adjustments under tax principles rather than GAAP. The beginning balance, changes during the year, and ending balance all appear on the K-1.
Electronic Filing
Partnerships submit Form 1065 through the IRS Modernized e-File system.4Internal Revenue Service. Modernized e-File (MeF) Internet Filing Electronic filing is mandatory for partnerships that file ten or more returns of any type during the calendar year — a threshold most partnerships cross once you count K-1s, W-2s, and 1099s together. A partnership that files on paper despite meeting the threshold risks additional penalties.
Schedule K-1: What Each Partner Receives
After completing Form 1065, the partnership prepares a Schedule K-1 for every partner. Allocations follow the partnership agreement, typically based on ownership percentages, though special allocations are permitted if they meet the substantial economic effect rules under IRC 704(b).5Office of the Law Revision Counsel. 26 USC 704 – Partners Distributive Share
The K-1 separates categories of income and deduction because they receive different treatment on the partner’s return. Ordinary business income, interest, dividends, capital gains, rental income, and charitable contributions each route to different lines or schedules on Form 1040. The K-1 also breaks out the partner’s share of partnership liabilities among recourse debt, nonrecourse debt, and qualified nonrecourse financing.6Internal Revenue Service. Partners Instructions for Schedule K-1 (Form 1065) Those liability figures affect how much of any loss the partner can actually deduct.
Most of the K-1 information flows onto Schedule E of Form 1040, which handles supplemental income and loss from partnerships, S corporations, and rental real estate.7Internal Revenue Service. About Schedule E (Form 1040), Supplemental Income and Loss Items like capital gains and charitable contributions go to their own forms and schedules.
When a K-1 Loss Isn’t Fully Deductible
A loss on your K-1 doesn’t automatically reduce your taxable income. Three separate limitations apply in sequence, and a loss must clear each one. Any amount blocked at one level carries forward.
Basis Limitation
Your deductible share of partnership losses cannot exceed your adjusted basis in the partnership at the end of the tax year.5Office of the Law Revision Counsel. 26 USC 704 – Partners Distributive Share Basis starts with your initial investment, rises with additional contributions and allocated income, and falls with distributions and deducted losses. Your share of partnership liabilities is part of basis, which is why the liability breakdown on the K-1 matters. Losses that exceed basis carry forward indefinitely and become deductible when your basis rises.8Internal Revenue Service. New Limits on Partners Shares of Partnership Losses Frequently Asked Questions
At-Risk Limitation
Even with sufficient basis, IRC 465 caps deductible losses at the amount you have at risk in the activity. The at-risk amount generally includes cash and property contributed plus your share of recourse debt, but typically excludes nonrecourse borrowing unless it qualifies under special real estate rules. For many limited partners this ceiling is lower than the basis ceiling, because nonrecourse debt counts toward basis but not toward at-risk. If a distribution pushes at-risk below zero, previously deducted losses may be recaptured. The calculation goes on Form 6198.
Passive Activity Limitation
The third hurdle is usually the tightest one for limited partners. Under IRC 469, a limited partner is presumed to be engaged in a passive activity, so losses can generally only offset other passive income, not wages or active business earnings.9Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited A limited partner can overcome the presumption only by meeting one of three material participation tests: more than 500 hours in the activity during the year, material participation in five of the preceding ten years, or material participation for three prior years in a personal service activity.10Internal Revenue Service. Publication 925 (2025), Passive Activity and At-Risk Rules Most passive investors won’t meet any of them. Disallowed passive losses carry forward and are fully released when you dispose of your entire interest in the partnership in a taxable transaction.
Self-Employment Tax
Self-employment tax is where general and limited partners diverge sharply. General partners owe self-employment tax on their entire distributive share because they run the business. Limited partners are excluded from self-employment tax on their distributive share; the only exception is guaranteed payments received for services actually performed for the partnership.11Office of the Law Revision Counsel. 26 USC 1402 – Definitions
The combined rate is 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare. The Social Security portion applies up to the wage base, which is $184,500 for 2026.12Social Security Administration. Contribution and Benefit Base Medicare has no cap, and an additional 0.9% surtax applies to self-employment income above $200,000 for single filers or $250,000 for joint filers. Misclassifying a general partner as a limited partner to sidestep this tax is a well-known audit trigger.
Net Investment Income Tax and the 199A Deduction
Higher-income limited partners face a 3.8% net investment income tax on passive partnership income once modified adjusted gross income exceeds $200,000 (single), $250,000 (married filing jointly), or $125,000 (married filing separately).13Internal Revenue Service. Questions and Answers on the Net Investment Income Tax The tax is calculated on the lesser of net investment income or the amount by which MAGI exceeds the threshold. Those thresholds are not indexed for inflation.
On the other side of the ledger, the Section 199A qualified business income deduction lets eligible partners deduct up to 20% of their qualified business income from the partnership. The deduction was made permanent by the One Big Beautiful Bill Act for tax years beginning after December 31, 2025. For 2026, phase-out begins at taxable income above $201,750 for single filers and $403,500 for joint filers, with W-2 wage and qualified property limits kicking in above those levels. Owners of specified service businesses lose the deduction entirely once taxable income exceeds $276,750 (single) or $553,500 (joint). The K-1 carries the data the partner needs to run the calculation, including whether the partnership is a specified service trade or business.
Estimated Quarterly Payments
Partnership income isn’t subject to withholding, so partners generally make quarterly estimated tax payments to avoid an underpayment penalty.14Internal Revenue Service. Estimated Taxes The 2026 due dates are April 15, June 15, September 15, and January 15, 2027.15Internal Revenue Service. Estimated Tax You can avoid the penalty by paying at least 90% of current-year tax or 100% of the prior year’s tax (110% if prior-year AGI exceeded $150,000). No penalty applies if you owe less than $1,000 at filing after withholding and credits.
Estimating is awkward because K-1s often arrive after the partnership’s year has closed. A common approach is to base early-year payments on the prior year’s K-1 and adjust in later quarters as the current year’s picture becomes clearer.
Filing Deadlines, Extensions, and Penalties
Calendar-year limited partnerships must file Form 1065 by March 15.16Internal Revenue Service. Starting or Ending a Business 3 Fiscal-year partnerships file by the fifteenth day of the third month after year-end. The K-1s must reach the partners by the same date.
Form 7004 grants an automatic six-month extension, moving the deadline to September 15 for calendar-year filers.17Internal Revenue Service. About Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns The request itself must be submitted by the original March 15 deadline. No reason is required.
Missing the deadline without an extension triggers penalties under IRC 6698. The penalty runs per partner, per month the return is late, for up to 12 months.18Office of the Law Revision Counsel. 26 USC 6698 – Failure to File Partnership Return The statutory base is $195 per partner per month, adjusted for inflation. The penalty covers each person who was a partner at any point during the year, not just those in the partnership on the last day. For a ten-partner partnership, even one late month runs well into the thousands.
A first penalty may qualify for first-time abatement if the partnership has filed all required returns for the prior three years and received no penalties during that period (or had prior penalties removed for acceptable reasons).19Internal Revenue Service. Administrative Penalty Relief The IRS grants these fairly routinely when the criteria are met.
If the Partnership Has a Foreign Partner
A limited partnership with any foreign partner takes on additional obligations under IRC 1446. The entity must withhold tax on the foreign partner’s share of effectively connected taxable income and report it on Form 8804 (the annual withholding return) and Form 8805 (the foreign partner’s statement).20Internal Revenue Service. About Form 8805, Foreign Partners Information Statement of Section 1446 Withholding Tax Payments can go through the Electronic Federal Tax Payment System. These rules apply whether the foreign partner is an individual or an entity, and failure to withhold can make the partnership itself liable for the tax plus interest and penalties.