The first step in preparation of the shareholder\'s K-1 is to take financial acc

Question

The first step in preparation of the shareholder's K-1 is to take financial accounting income (loss) and adjust it to net taxable income (loss). The second step is to break out the net taxable income (loss) into the various separately-stated items of income, deduction, etc. Why do you suppose that flow-through entities must report the shareholder's share of separately-stated items? Why not just report the shareholder's allocation of net taxable income (loss)? Take one separately-stated item and tell us what the limitation is at the shareholder level. For example, Section 179 depreciation expense must be separately stated on the K-1 because the deduction is limited to the shareholder's taxable income.

Explanation / Answer

Partnerships and Corporations are recognized as pass-through entities because they normally don’t pay income tax. Instead the business income flows through to the partners or shareholders who then file and pay tax on any income. So every year when tax season spins in partnerships must file Form 1065 with the IRS whereas part of that form requires filling out and issuing Schedule K-1 to each of their partners or shareholders.

Schedule K-1 does facilitate partners and shareholders to report their shares of income, deductions and credits to the IRS on their tax returns normally via Form 1040. Furthermore it helps to elucidate partner’s profits and losses related to business and non-business activities such as interest, dividends and capital gains.

Its important firms issue K-1 to partners or shareholders on or before the deadline of the partnership or corporation’s tax return. If partners and shareholders file their individual returns without their concluding K-1 then their return might be missing key information’s pertaining to partner’s gains and losses from business. If this takes place then they would need to amend their returns after the risk of having to deal with local or federal tax authorities with questions about incomplete information.

Section 179 of US Internal Revenue Code facilitates taxpayer deduction with cost of certain types of property on their income taxes as an expense rather than requiring the cost of the property to be capitalized and depreciated. However there is dollar limitation where the maximum deduction a taxpayer may elect to take in a year is $1,000,000 applicable as on 1st January, 2018.

If a taxpayer invests more than $2,000,000 worth of section 179 property into service during a single taxable year then the deduction is reduced by the amount exceeding the threshold limit of $2,000,000. Furthermore it provides that taxpayer's deduction for any taxable year should not exceed taxpayer's total earnings from trade or business by the taxpayer for that particular year.

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