K-1 Income With No Distribution: Taxed on Money You Never Got

Why do I owe tax on K-1 income I never received?

A partnership or S corporation generally does not pay income tax on its profit; its owners do, on their share, whether or not the company paid out any cash. The IRS says so in the instructions for the partner's K-1 and the S corporation shareholder's K-1. The law puts the tax on the owner: section 701 for partners and section 1366 for S corporation shareholders.

The K-1 follows tax income, not the bank balance. A company can keep its cash for debt, equipment, inventory or a cushion and still report a profit. This is often called phantom income, and it covers every income line on the K-1, not only ordinary business income: interest, rental income and gain on a sale of company assets are part of your share too.

A case is not simple when:

• You are not sure which kind of company it is: the K-1 says Form 1065 (a partnership, including an LLC taxed as one) or Form 1120-S (an S corporation), and self-employment tax generally applies to the first and not the second.
• Other owners were paid and you were not.
• The K-1 does not match the business you see, or the books are thin.
• The K-1 is late, or the company never filed.
• The bill is larger than the cash you have.

If the bill is more than you can pay, other owners were paid and you were not, or the K-1 does not fit the business you see, the K-1, the agreement and the books need to be read together by a professional; the last section says where each case goes.

Gather these first:

• The K-1 with every attached statement.
• The operating or shareholder agreement and its amendments.
• The company's year-end profit and loss and balance sheet.
• On a partnership K-1, the capital account (item L).
• A dated list of what you were paid, lent or put in during the year.

Do I have to report K-1 income if I got no cash, and where does it go?

You do not file the K-1 yourself: the company files it and sends you a copy (partner's instructions). You report your share on your own return, paid or not, if you are required to file one. An individual reports ordinary business and rental income in Part II of Schedule E (Form 1040), which asks for the share of income even if not received. Other K-1 items go where their box instructions send them: interest and dividends on Form 1040, capital gains on Schedule D, and gains on business property on Form 4797 (partner's instructions, shareholder's instructions). Keep the K-1; do not attach it unless the instructions tell you to.

On Schedule E you mark the income passive or nonpassive. It is passive if you did not materially participate, meaning regular, continuous and substantial involvement in operations (section 469(h)); most rental activity is passive too, and a limited partner generally is not treated as participating (Schedule E instructions). The label decides which of your other losses can offset the income and whether the net investment income tax below can apply; see business losses.

An S corporation shareholder files Form 7203 when claiming a deduction for a share of the company's losses, receiving a distribution that is not a dividend, disposing of stock or receiving a loan repayment. If none of those four applies, the form is not required for the year, though the IRS says completing it anyway may help keep basis consistent from year to year.

This page covers federal tax. States have their own rules for taxing K-1 income and for estimated payments.

Do I owe self-employment tax on K-1 income?

It depends on the entity. An S corporation shareholder's share is not self-employment income. A partner's share of ordinary business income generally is, whether or not it was paid out, unless the partner is a limited partner.

Partnership. A partner's distributive share of trade or business income counts toward net earnings from self-employment regardless of distribution (section 1402(a)). Box 14, code A of the K-1 reports it, and Schedule SE (Form 1040) figures the tax (partner's instructions). Self-employment tax is 15.3% of 92.35% of net earnings: 12.4% for Social Security on earnings up to the wage base of $184,500, counted together with any wages you also earned, and 2.9% for Medicare on all of it.

Limited partners. Section 1402(a)(13) leaves out a limited partner's share, other than guaranteed payments for services. The IRS instructions say whether a member of an LLC counts as a limited partner for self-employment tax depends on that section, so the answer turns on the facts. For a member who works in the business, it is worth professional review before you file; see corporate tax help.

S corporation. The shareholder's instructions say the share is not self-employment income. A shareholder who works in the business is a separate question: the Form 1120-S instructions require payments to an officer to be treated as wages to the extent they are reasonable pay for services. An owner who works full time and was paid neither wages nor distributions raises that question; see S corporation owner salary.

Other federal taxes. If you did not materially participate in the business, your share can also be subject to the 3.8% net investment income tax once your modified adjusted gross income is above $200,000 (single or head of household) or $250,000 (married filing jointly); other filing statuses have their own thresholds. Income counted as self-employment income is excluded from it, and interest, dividends and gains on the K-1 can be subject to it even if you work in the business (IRS, Form 8960 instructions). A partner whose wages and self-employment earnings together pass $200,000 (single or head of household) or $250,000 (married filing jointly; other statuses differ) also owes the 0.9% Additional Medicare Tax on the excess (IRS).

Do I have to make estimated tax payments on K-1 income?

Often yes. A K-1 share is not wages, so no paycheck withholding covers it and quarterly payments are how most owners pay during the year. Publication 505 says you generally must pay estimated tax if you expect to owe at least $1,000 after withholding and credits, and expect withholding and credits to be less than the smaller of 90% of this year's tax or 100% of last year's tax. The last-year test is 110% if last year's adjusted gross income was over $150,000 ($75,000 if you are married filing separately).

Your share counts in your tax year in which the company's tax year ends (section 706(a) for partners, section 1366(a)(1) for S corporation shareholders), not the year the K-1 arrives or cash is paid. Three ways to limit a penalty when you learn the number late:

• Compare with last year's tax. The last-year test above uses last year's tax, which can be far below this year's when the K-1 income is new. It applies only if last year's return covered 12 months.
• Use the annualized income installment method. It figures each installment on the income earned to date, which fits income that arrives unevenly. Publication 505 says to file Form 2210 if you use it.
• Raise your withholding. If you have wages, extra tax withheld from them counts as paid in equal parts on each installment date unless you show when it was withheld (section 6654(g)), so a late change can still cover earlier quarters.

Payment dates and amounts are in the quarterly estimated tax guide. For an S corporation shareholder, including whether the company can pay your estimates for you, see S corporation estimated tax payments.

What if I cannot pay the tax on income I never received?

File on time anyway and pay what you can: a late return costs 5% of the unpaid tax per month, up to 25%, reduced by the late-payment penalty for the same months (failure to file penalty), and the IRS says filing on time matters even when you cannot pay in full (payment plans).

Unpaid tax carries a late-payment penalty of 0.5% per month, up to 25%, plus interest at 7% for the current quarter. The penalty drops to 0.25% per month during an approved plan if you filed on time. The IRS offers two plan types:

Interest and penalties keep running until the balance is paid, and a plan does not shrink the tax. Another route is to ask the company for a distribution to cover the tax; whether you can require one depends on your agreement.

Does the tax I pay now come back to me later?

It comes back as basis, not as a refund. Basis is your tax investment in the company. Income you report raises it, so cash paid out later, or a sale of your interest, generally comes out against basis instead of being taxed a second time.

• Partnership. Section 705 raises a partner's basis by their share of income. A distribution lowers basis, and gain arises only to the extent money paid exceeds basis. On a sale of the interest, gain or loss is the amount realized less basis (Publication 541).
• S corporation. Section 1367 raises basis by income items, but only to the extent the income is included in your gross income on your return. If earlier losses reduced the basis of a loan you made to the company, the year's net increase restores that loan basis first, and loan basis does not shelter a stock distribution (Form 7203 instructions). A distribution from an S corporation with no profits left over from years when it was a C corporation is not income up to stock basis; the excess is gain (section 1368).

Basis is yours to track. The capital account the company reports for you on a partnership K-1 (item L) is based on the company's books and records, and the IRS instructions say it can't be used to figure your basis; partnership basis also includes your share of company debt. See partner capital accounts and S corporation shareholder basis.

Can I make the company pay a tax distribution?

Only if your agreement or state law gives you that right; the tax rules do not. The tax rules tax you on your share but do not require the company to pay cash to cover it. What the agreement lets you enforce is a legal question. These are the terms to look for:

An S corporation is different: more than one class of stock ends S status (section 1361(b)(1)(D)), so a payout to some shareholders and not others is not a simple fix. See unequal S corporation distributions.

Make the request in writing, state the K-1 amount and keep the reply. How LLC members take money out is in paying yourself from an LLC.

What if other owners were paid and I was not?

Your share of the income is generally set by the agreement (partnership, section 704(a)) or by your stock (S corporation, section 1366(a)(1)), not by what other owners were paid. A partnership distribution is not taken into account in figuring that share (Publication 541). What changes is the capital accounts: an owner who took less ends with a higher capital account than one who took more.

Ask what each payment was:

Unequal draws by partners may be allowed. Whether draws must be proportional is a question for the agreement, so ask for the distribution history by owner and compare it with the agreement before drawing a conclusion. How the company books each kind of payment is in guaranteed payments versus partner draws. For an S corporation, unequal distributions can raise a second-class-of-stock question; see the S corporation guide.

How do I check that the K-1 number is right?

Compare the K-1 with the company's own profit and loss, the percentages in the agreement, and your records of what you put in and took out. K-1 income follows tax rules, so it may not match cash or book profit. Ask the company for:

A small company may not have to complete some of these schedules (Form 1065 instructions, Form 1120-S instructions); if so, ask for the workpapers behind the K-1.

If the company cannot produce books that support the K-1, or the numbers do not reconcile, the K-1 itself may be wrong, and the books need review before the return relies on it; see bookkeeping help.

What if the K-1 is late, or I think it is wrong?

A late K-1 does not move your due date. An extension of your own return (generally to October 15) is only for filing: the IRS says to pay what you owe by the April date (extensions). The choice between extending and filing on estimates is in the late K-1 guide, written for fund investors.

If you think a K-1 is wrong, ask the company for a corrected one and do not change your copy; be sure the company sends the correction to the IRS (K-1 instructions). An S corporation, or a partnership that elected out of the centralized partnership audit regime (the rules that let the IRS assess the partnership itself), generally corrects the K-1. A partnership under that regime, once its filing period (extensions included) has ended, generally files an administrative adjustment request instead, and any adjustment passed to partners comes on Form 8986, not a new K-1 (section 6031(b), Form 1065 instructions); see correcting a filed business return.

Form 8082 (Notice of Inconsistent Treatment) tells the IRS when your return treats an item differently from the company's, when the company has not filed, or when it has not given you a K-1 by the time your own return is due, extensions included, and you have items to report (Form 8082 instructions). Leaving it out can add an accuracy-related penalty. For a partnership, the form is available only if it has not elected out of the centralized partnership audit regime. For an S corporation, file it if you cannot agree with the company on the inconsistency (S corporation instructions).

A partnership must furnish K-1s by the date its return is required to be filed (section 6031(b)); an S corporation, by the day it files its return (section 6037(b)), though the Form 1120-S instructions say the day it is required to be filed. A calendar-year partnership's return is due March 15 and an S corporation's March 15. A company with a Form 7004 extension may send K-1s as late as September 15 for a calendar-year company (Form 7004 instructions), so ask whether it extended; see business extensions. A company that does not furnish a K-1 when due can face a penalty for each one (Form 1065 instructions, Form 1120-S instructions).

If the company never filed, see catching up on unfiled business returns; if the K-1 was wrong after it filed, see correcting a filed business return.

Example

These examples are illustrative; figures are in US dollars.

A partner whose LLC kept the cash

A partner owns 25% of a four-member LLC taxed as a partnership. The LLC earns US$200,000 and keeps the cash for inventory. The K-1 shows US$50,000 in box 1 and nothing in box 19. The partner reports US$50,000 on Schedule E. At an assumed 24% marginal rate and before any deductions, income tax on it is about US$12,000. The qualified business income deduction (Form 8995 instructions) and the deductible part of self-employment tax can lower that. If the share is subject to self-employment tax, add about US$7,065 (US$50,000 × 92.35% × 15.3%); that income is excluded from net investment income tax. If the share is instead excluded from self-employment tax, as a limited partner's may be, and the partner did not materially participate, the net investment income tax may apply. Basis rises by US$50,000, so a later distribution of up to that amount generally would not be taxed again.

An S corporation shareholder, year by year

A shareholder who does no work for the company owns 30% of an S corporation, with stock basis of US$10,000. In year one the company earns US$100,000 and pays no one. The K-1 shows US$30,000. The shareholder reports it. The K-1 share is not self-employment income, though a passive owner may owe net investment income tax on it. Basis becomes US$40,000. In year two the company breaks even for tax and pays all shareholders US$100,000 in proportion to shares, US$30,000 to this shareholder. With no profits left over from years when it was a C corporation, that US$30,000 is a non-dividend distribution under basis, so it is not income, and basis falls to US$10,000. The shareholder files Form 7203 that year.

Three partners, unequal payouts

Three equal partners share a US$180,000 profit, US$60,000 each. All three report US$60,000. Assume A and B each started the year with at least US$20,000 of basis (ignoring partnership debt), so their draws, treated as taken on the last day of the year, are not taxed.

With less basis, the part of a draw above basis is taxable gain; a falling capital account does not show that (Publication 541). Partner C's questions are what the agreement says about draws above a partner's share, and when C will be paid.

Different for you?

• The bill is more than you can pay: how to pay or plan it depends on your whole return. See individual tax help.
• Other owners were paid and you were not, or your share does not match the agreement: a professional has to read the agreement to say how your share should be allocated and what you can ask for. See corporate tax help.
• The K-1 does not fit the business, or the books are thin: a review of the books behind the K-1 comes first. See bookkeeping help.
• An S corporation distribution is larger than your basis: see distributions above basis.
• You need to work out basis or your capital account is negative: see S corporation shareholder basis, partner capital accounts and negative capital account.
• You need the general rules: see how partnerships are taxed and how S corporations are taxed.
• The company never filed, or a filed return was wrong: see catching up on unfiled business returns and correcting a filed business return, with corporate tax help.
• You live outside the US: a partnership may have to withhold tax on a foreign partner's share (Publication 541). See Canadian partner in a US LLC or a US company with a foreign co-owner.