Form K-1 reports the individual shareholder’s share of income and/or loss, as well as various “flow-through” items of income and expense. Unlike the Form K-1 for partnerships (Form 1065 discussed below), the S corporation K-1 does not present capital balances at the beginning and end of each year. Look at Box F of the Form K-1 and notice if the percentage of ownership has changed compared to previous years. If it has, request all agreements regarding change of ownership. Box 16 of the Form K-1 reports distributions to the shareholder.
Form 1065—Partnership Tax Return (“Pass-Through Entity”)
Form 1065 is used for a general partnership, limited partnership, limited liability corporation, and limited liability partnership. Similar to the S corporation, partnership tax returns represents tax reporting for a “pass-through entity.”
The top of page 1 presents the name, business address, employer ID number, the date the partnership started, and business activity and code.
Page 1 also sets forth whether the partnership reports its income under the cash or accrual method of accounting (most often cash basis, for professional practices). Line items that should be looked at in the first instance are as follows:
- Line 1, which reports the gross receipts received from customers.
- Line 10, which reports guaranteed payments to partners. A partnership does not pay wages to its partners; rather they may have “guaranteed payments.”
- Line 20, which reports “other deductions” and should be supported by a detailed statement in the back of the tax returns. These “other expenses” present a good starting point for identifying non-essential expenses or perks.
- Line 22, which reports the income and/or (loss) of the partnership.
Pages 2 and 3
Schedule B reports whether or not there are other partners who are partnerships (i.e., foreign business partners).
Schedule K reports the partners’ aggregate of income, deductions, credits, etc. (and mirrors individual Form K-1’s for each partner).
Schedule L of the Form 1065 presents the balance sheet. Similar to the Form 1120S, notable line items for the partnership balance sheet are as follows:
- Line 2, which reports accounts receivable if the partnership reports its income under the accrual method of accounting. If the partnership reports its income under the cash basis of accounting, it is important to ask if there are amounts due to the partnership from its customers. If yes, request a detailed accounts receivable report.
- Line 6, which reports other assets. If there is not a detailed statement in the back of the tax return, request one to identify what these “other assets” consist of.
- Line 9, which reports the fixed assets at their cost. Request a detailed fixed asset list and determine if appraisals are needed.
- Line 21, which reports the partners’ capital balances based on the method of accounting utilized, (i.e., accrual vs. cash).
Unlike the individual Form K-1 of the S Corporation, the partnership Form K-1 presents beginning and end-of-year capital balances, as well as capital contributions and withdrawals (See Line J on the left hand side of each Form K-1).
- Box L presents the beginning and ending capital account balance.
- Box 19 reports any distributions.
Form 1120—C Corporation Tax Return
C corporations are taxed on the income they report. Dividends paid to stockholders are not deductible by the corporation and are reported as income to the stockholder when received. This is what is meant by “double taxation”—the corporation pays taxes on the income, and when the income is paid to the stockholder as a dividend, the stock holder pays taxes on the dividend.
As with the other types of business tax returns the top of page one presents: business name, address, and date incorporated. The income and expense line items (lines 1a through 30) are self-explanatory. Line 31 reports the amount of total tax the corporation is responsible for; Line 32 reports total tax payments made throughout the year; and Line 34 reports the total tax due. If there was an overpayment of estimated taxes, Line 35 reports the amount of the overpayment.
At the bottom of page 3, within Schedule K, the type of accounting method (cash or accrual), business code, and business activity are listed.
On this page, the balance sheet for the corporation is reported within Schedule L. See the discussion on the balance sheet for S corporations and partnerships above.
This schedule is unique to the corporation tax return and reports the officer’s names, social security numbers, percentage of stock owned (if any), and their individual compensation.
In summary, the business tax returns contain useful financial information if you know how to read them. This Practice Point was written to take you through a high level guided tour of the information reported to the IRS and how you can use that information in your discovery process.