Form 1065 Explained: Partnership Taxation for EA Candidates

2026-07-10

Last reviewed: July 9, 2026. This article reflects current IRS rules and EA exam requirements as of this date.

Form 1065 is the U.S. Return of Partnership Income. The key concept: partnerships don't pay federal income tax. All income, deductions, and credits pass through to the partners. This is the foundation of Part 2 business taxation.

The Flow-Through Concept

A partnership earns $500,000 in ordinary business income. The partnership files Form 1065 and issues Schedule K-1 to each partner showing their share. The partnership pays $0 in tax. Each partner reports their K-1 income on their individual 1040 and pays tax at their personal rate.

This is fundamentally different from a C corporation (Form 1120), which pays tax at the entity level, then shareholders pay tax again on dividends.

What's on Form 1065

Page 1. Income and Deductions: Same categories as Schedule C: gross receipts, COGS, ordinary business expenses. Net ordinary business income flows to Schedule K.

Schedule K. Partners' Distributive Share Items: The big one. Breaks income into categories because different types of income get different tax treatment on the partner's return:

Ordinary business income (taxed at ordinary rates)
Net rental real estate income (passive)
Interest income (ordinary rates)
Dividends (qualified dividend rates)
Capital gains (short-term or long-term rates)
Section 179 deduction
Charitable contributions
Investment interest expense
Self-employment earnings

Schedule K-1. Partner's Share of Income: Each partner gets one. Shows exactly how much of each income category belongs to that partner. The partner enters each item on the appropriate line of their individual 1040.

Example: Two Partners, Unequal Shares

Alex and Blake are 60/40 partners. The partnership has:

$300,000 ordinary business income
$10,000 interest income
$5,000 charitable contributions

Alex's K-1: $180,000 ordinary income, $6,000 interest, $3,000 charitable
Blake's K-1: $120,000 ordinary income, $4,000 interest, $2,000 charitable

Each reports their share on their individual return. The partnership reports the totals on Form 1065.

Partner Basis. The EA Exam's Heavy Hitter

Outside basis = the partner's investment in the partnership. Calculation:

Increases basis: Capital contributions, share of partnership income, share of partnership liabilities, additional investments

Decreases basis: Distributions (cash or property), share of partnership losses, share of liability reduction

A partner cannot deduct losses in excess of basis. If a partner has $5,000 of outside basis and the K-1 shows a $7,000 loss, only $5,000 is deductible. The remaining $2,000 carries forward to future years when basis is restored.

Due Date

March 15. a month and a half before the individual 1040 deadline. Six-month extension available (September 15). Partners need their K-1s before they can file their individual returns, which is why the partnership deadline is earlier.

Common EA Exam Traps

Trap 1: Guaranteed payments. If a partner receives a guaranteed payment for services, it's ordinary income to the partner and a deduction for the partnership. But it's not subject to self-employment tax if the partner is a limited partner. The distinction between general and limited partners matters here.

Trap 2: Section 179 deduction flows through on K-1 and applies at the partner level. Each partner has their own §179 limit. The partnership's use of §179 reduces each partner's individual limit by their share.

Trap 3: Non-liquidating distributions. Generally not taxable unless cash distributed exceeds the partner's basis. Property distributions take carryover basis in the partner's hands.

Need to reference Form 1065 or other IRS forms? The IRS Form Lookup has 19 forms with purpose, filing rules, and EA exam relevance.

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