Filing Your Partnership Return - Basic Concepts
We get many questions from clubs that have never used any accounting software as to how they should go about filing a partnership return. A complete treatise on the subject would entail writing a book, but here are some of the more salient points.
Federal Tax Form 1065, U.S. Partnership Return of Income, is an information return. That is to say no payment of tax is involved on the partnership level. The return serves to alert the IRS and each partner as to what each member should be reporting on his/her individual (1040) return.
For an investment club, typically, lines 1 through 22 on the first page of the return are blank. The 'meat' of the information is provided on Page 3 (Schedule K) and the K-1 Schedules for each partner. In our basic example, we will contemplate a club that has dividend and interest income, capital gains, and deductions related to portfolio income. We will also assume that one member left the partnership during the year and realized a gain on doing so.
If the club sold some securities during the year, Schedule D (Capital Gains and Losses) should be filled out before attempting to enter the data on Page 3 (Schedule K). If the stock that was sold was held for more than one year, enter the pertinent data in Part II. If, on the other hand, the holding period was less than one year, enter the data in Part I. Read the instructions for Schedule D and bring the totals down to Lines 5 and/or 12. We will assume there was a long-term gain, and it amounted to $800 being entered on line 12 of the Schedule D.
Now we are ready to tackle Page 3 (Schedule K). Enter the total interest income for the club on line 4a. Enter dividend income on 4b. Enter our $800 long-term capital gain on line 4e(2). Do not enter anything in the section where it says 28% gain.
Let's assume that the club had $320 of expenses, primarily copying charges. This amount should be entered on Line 10.
On Line 14a you should enter the total of items 4a, 4b, 4c, and 4f. On line 14b you should enter the amount on line 10.
On line 22, enter the amount of cash paid out to the departing partner.
Schedule K is now complete. You should attach a schedule in support of the expense items on line 10. This schedule, in our case, could just say Copying Charges, etc.        320.
To fill out each partner's K-1, it is only necessary to determine his/her applicable share of each item on the Schedule K. You will note that the line numbers on Schedule K-1 match exactly the line numbers on Schedule K. Determining each partner's share could be slightly involved. We recommend unit-based accounting, which lets you have partners with unequal positions of ownership. We will assume in this case that the club had 10 equal partners. We still have to face up to the problem that one partner left during the year. You could allocate each item on Schedule K to the partners in accordance with their ownership at the time the event happened. In other words, if a dividend came in on December 15th and the partner left in July, that partner would not be allocated any portion of the December dividend. Another way to compute it is to allocate the departing member his/her share of all income/expense items depending on how many months that member was in the club. For instance, if the member left on June 30, you would say that this member should be allocated 1/10th of 1/2 of each item on Schedule K (or 1/20th). Subtract that number from each item, and allocate 1/9th of the result to the remaining partners.
I'm going to take the easy way out and assume that the partner left on December 31, thus making him a 1/10th partner for the entire year. In that case, with the exception of Line 22, enter 1/10th of the Schedule K amount on the appropriate line on the each partner's K-1. On line 22 for the departing member, enter the total of the amount on line 22 of Schedule K.
There, you have it. That takes care of Form 1065 (after you sign it, and answer all questions, of course). There is one matter remaining. The departing member will have to report the gain on leaving the partnership on his/her Schedule D of the 1040. This partner has enough information to reflect the transaction, but most treasurers would supply the necessary data. On the individual's Schedule D, the sales amount would be the proceeds received. The cost amount would be the total amount paid in, plus or minus any Schedule K-1 items allocated during the period that person was a partner. The gain would be long-term or short-term depending on the length of time he/she was a partner.
This may seem a bit overwhelming, but if you follow the steps exactly, you should have a return that complies with IRS rules and regulations. This entire discussion should point out the benefits of software that will do all these burdensome tasks for you.
As always, if there are further questions, or I have been particularly unclear, please come back.
Rip West
Ridgway, CO