K-1 earnings are taxed on your personal return at rates that depend on what kind of income each box represents: ordinary business income at your regular bracket, long-term capital gains and qualified dividends at preferential rates, and certain amounts at additional layers like self-employment tax or the 3.8% net investment income tax. The business itself generally pays no federal income tax on these amounts; the obligation shifts to you, and it applies whether or not the entity actually distributed cash. For 2026, a permanent 23% deduction on qualified pass-through income can shelter a meaningful slice of what you report.
Where Your K-1 Came From Changes the Answer
Three kinds of entities issue Schedule K-1s, and the source shapes how the income hits your return.
A partnership pays no federal income tax itself; each partner is taxed individually on an allocated share of profits, and that share follows the partnership agreement rather than a strict ownership percentage.1Office of the Law Revision Counsel. 26 USC Subtitle A, Chapter 1, Subchapter K – Partners and Partnerships A 60% capital partner can be allocated 40% of income if the partners agreed to that split.
An S corporation also passes most earnings through untaxed at the entity level, but allocations must be strictly proportional to share ownership.2Office of the Law Revision Counsel. 26 USC Subtitle A, Chapter 1, Subchapter S – Tax Treatment of S Corporations and Their Shareholders
Estates and trusts issue a Schedule K-1 (Form 1041) to beneficiaries showing their share of interest, dividends, capital gains, business income, and other items.3Internal Revenue Service. Instructions for Schedule K-1 (Form 1041) for a Beneficiary Filing Form 1040 or 1040-SR (2025) The trust or estate takes a deduction for distributed amounts, so tax falls on the beneficiary.
How Each Type of Income on the Form Is Taxed
A K-1 splits your share into categories because the tax rate depends on the category. That’s the whole reason the form has so many boxes.
Ordinary Business Income
Box 1 on a partnership K-1 reports your share of ordinary income from operations. This is taxed at your individual rate, which for 2026 ranges from 10% to 37%.4Internal Revenue Service. IRS Releases Tax Inflation Adjustments for Tax Year 2026 S corporation ordinary income works the same way at the individual level.
Rental Real Estate Income
Net rental real estate income sits in its own box and is generally treated as passive income, meaning losses can only offset other passive income. If you actively participate, you can deduct up to $25,000 of rental losses against non-passive income, but that allowance phases out between $100,000 and $150,000 of adjusted gross income.5Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited
Interest, Dividends, and Capital Gains
Interest and dividends earned inside the entity keep their character on the way to you. Qualified dividends are taxed at 0%, 15%, or 20% rather than at ordinary rates.6Internal Revenue Service. Topic No. 404, Dividends and Other Corporate Distributions Capital gains also flow through with their character intact: if the partnership held an asset more than a year, your share of the gain is long-term regardless of how long you’ve been a partner, and it gets the same preferential rates as qualified dividends.7Internal Revenue Service. Topic No. 409, Capital Gains and Losses
Guaranteed Payments
Box 4 guaranteed payments to a partner for services or for use of capital are taxed as ordinary income whether the partnership is profitable or not. They’re always treated as earned income to the partner, which matters for self-employment tax.
Deductions and Credits That Flow Through
Your K-1 also carries your share of the entity’s charitable contributions, Section 179 depreciation, and various credits. For 2026, the maximum Section 179 deduction is $2,560,000. Credits for foreign taxes paid or research activities reduce your tax bill dollar for dollar.
The 23% Qualified Business Income Deduction
Owners of partnerships and S corporations may shelter a large portion of qualifying income through the qualified business income deduction. Under the One Big Beautiful Bill Act, this deduction was made permanent and increased to 23% of qualifying pass-through income for 2026 and later years.8U.S. House Committee on Ways and Means. The One, Big, Beautiful Bill It was previously 20% and had been scheduled to expire after 2025.
Full eligibility applies when 2026 taxable income is below roughly $201,750 for single filers or $403,500 for joint filers. Above those thresholds, limitations phase in based on W-2 wages paid by the business and its qualified property. Owners of specified service businesses in law, accounting, healthcare, and consulting lose the deduction entirely once income exceeds roughly $276,750 single or $553,500 joint.
Claim it on Form 8995 or Form 8995-A.9Internal Revenue Service. About Form 8995, Qualified Business Income Deduction Simplified Computation The entity itself doesn’t take the deduction; it passes the underlying figures through on an attachment to your K-1. Missing this line is one of the more common ways K-1 recipients overpay.
You Owe Tax on Income You Didn’t Receive
This is the trap that catches new K-1 recipients. You owe tax on your allocated share whether or not the business sent you a check. A 25% partner in a partnership that earned $200,000 and reinvested every dollar still reports $50,000 of income. The IRS calls this your distributive share, and it is taxable in the year the business earns it.10Internal Revenue Service. What Is Taxable and Nontaxable Income?
The counterweight is basis. Phantom earnings that you pay tax on now raise your basis in the entity, so when cash is eventually distributed it comes out tax-free up to that basis. You aren’t taxed twice; you’re taxed earlier than the cash arrives.
Many well-run partnerships and S corporations handle this by making “tax distributions” sized to cover the top marginal rate. If yours doesn’t, plan for estimated payments. Underpaying can trigger a 20% accuracy-related penalty on the shortfall.11Office of the Law Revision Counsel. 26 USC 6662 – Imposition of Accuracy-Related Penalty on Underpayments
Self-Employment Tax and the 3.8% Investment Tax
General partners owe self-employment tax on their share of ordinary business income. For 2026, the combined rate is 15.3%: 12.4% Social Security on earnings up to $184,500 and 2.9% Medicare with no cap.12Social Security Administration. Contribution and Benefit Base An additional 0.9% Medicare surtax applies to self-employment income above $200,000 single or $250,000 joint.
Limited partners generally exclude their share of ordinary partnership income from self-employment tax.13Office of the Law Revision Counsel. 26 USC 1402 – Definitions The exclusion never covers guaranteed payments for services, which always carry self-employment tax.
S corporation shareholders don’t pay self-employment tax on distributions at all. Instead, shareholder-employees have to draw a reasonable salary through payroll, which carries employment taxes. Setting that salary artificially low is one of the most common S corporation audit triggers.
On top of income tax, the 3.8% net investment income tax applies once modified adjusted gross income crosses $200,000 single or $250,000 joint. Those thresholds aren’t indexed for inflation. The tax hits passive business income, rental income, capital gains, interest, and dividends reported on your K-1. It does not hit income from a trade or business in which you materially participate. You calculate it on Form 8960. Whether you’re a silent investor or actively running the operation can be the difference between owing the 3.8% or not.
When K-1 Losses Actually Reduce Your Tax
A loss on your K-1 doesn’t automatically offset your other income. It has to clear three hurdles, applied in order.
Basis comes first. You can deduct losses only up to your adjusted basis in the entity. Partnership basis starts with your contribution and adjusts up for allocated income and additional contributions and down for distributions and losses.14Office of the Law Revision Counsel. 26 USC 704 – Partner’s Distributive Share S corporation basis includes stock basis plus the adjusted basis of any loans you personally made to the corporation.15Office of the Law Revision Counsel. 26 USC 1366 – Pass-Thru of Items to Shareholders Losses beyond basis carry forward until basis grows enough to absorb them.
At-risk rules come next. Losses are further capped at the amount you have at risk: cash and property contributed plus amounts borrowed for which you’re personally liable. Money shielded by guarantees or stop-loss agreements, or borrowed from related parties with interests in the activity, typically doesn’t count.16Internal Revenue Service. Instructions for Form 6198 Qualified nonrecourse financing on real property in a real estate activity is treated as at-risk.
Passive activity rules come last. If you don’t materially participate, surviving losses can offset only passive income, not wages, interest, or portfolio income.5Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited Disallowed passive losses carry forward and become fully deductible when you dispose of your entire interest in a taxable sale to an unrelated party.17Internal Revenue Service. 2025 Instructions for Form 8582 – Passive Activity Loss Limitations Losses from publicly traded partnerships are tighter still: they can only offset income from the same publicly traded partnership.
Reporting the Income on Your Return
K-1 income from partnerships and S corporations goes on Schedule E (Form 1040), Part II, and totals feed into your Form 1040.18Internal Revenue Service. 2025 Instructions for Schedule E (Form 1040) – Supplemental Income and Loss K-1 income from an estate or trust may route to different schedules depending on character: interest and dividends to Schedule B, capital gains to Schedule D.3Internal Revenue Service. Instructions for Schedule K-1 (Form 1041) for a Beneficiary Filing Form 1040 or 1040-SR (2025) Each K-1 shows the entity’s EIN and your identifying number so the IRS can match records.19Internal Revenue Service. Partner’s Instructions for Schedule K-1 (Form 1065) (2025)
What to Do If Your K-1 Is Late
Partnerships and S corporations must furnish K-1s by the 15th day of the third month after year-end, which is March 15 for calendar-year entities.20Internal Revenue Service. Publication 509 (2026), Tax Calendars Many file for a six-month extension, pushing delivery toward September 15.21Internal Revenue Service. About Form 7004, Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns
If yours isn’t in hand by April 15, file Form 4868 for an automatic extension to October 15, or estimate the K-1 figures from prior-year numbers and amend later.22Internal Revenue Service. IRS – Need More Time to File, Request an Extension An extension to file is not an extension to pay. Skipping filing without an extension triggers a failure-to-file penalty of 5% of unpaid tax per month, up to 25%.23Internal Revenue Service. Failure to File Penalty Extending and paying your best estimate of the tax owed is almost always the right call while a K-1 is outstanding.