Partnerships and Form 1065: How a Business With Two Owners Files

Two friends start a fencing company. A husband and wife open a store. Three siblings inherit the family land and lease it out together. In each case, a business with more than one owner has come into existence, and unless it elected otherwise, it is a partnership for federal tax purposes. That means a return most people have never heard of, a deadline that arrives earlier than they expect, and a form for each owner that decides what lands on their personal return.

What makes a partnership

You do not need a written agreement or a filing with the state. If two or more people carry on a business together and share the profits, a partnership exists by default. A multi-member LLC that has not elected corporate treatment is taxed as a partnership. So is a general partnership formed on a handshake. The main exception is a married couple in a community property state like Texas, who may in some cases treat a jointly owned business as two sole proprietorships instead. That choice has consequences for both spouses and is worth making deliberately.

How the entity choice fits with the alternatives is covered in Choosing a Business Entity.

The partnership does not pay income tax

Form 1065 is an information return. The partnership reports its income, deductions and credits, and then allocates them among the partners according to the partnership agreement or, if there is none, according to ownership. The partnership itself owes no federal income tax. Each partner receives a Schedule K-1 showing their share, and each partner reports that share on their own return whether or not any cash was actually distributed to them.

That last point is the one that surprises new partners. A partnership that earned a profit and reinvested it in inventory or equipment still produces taxable income to the partners. Reading the K-1 is a skill of its own, and we walk through it in Reading a Schedule K-1.

The deadline is earlier than the personal return

For a calendar-year partnership, the return is due in March, a month before individual returns. The reason is practical: partners cannot file their own returns until they have their K-1s. Missing the partnership deadline triggers a penalty calculated per partner, per month, which adds up quickly for a small business that simply did not know a return was required. An extension is available, but it has to be filed by the original due date.

Guaranteed payments and self-employment tax

Partners are not employees of their own partnership and cannot be put on its payroll. When a partner is paid for services regardless of the partnership's profit, that amount is a guaranteed payment, deductible to the partnership and ordinary income to the partner. A general partner's share of the business income, plus guaranteed payments, is generally subject to self-employment tax. This is a major difference from the S corporation structure, where owner wages and distributions are treated differently, and it is often what drives a partnership toward an S election as profit grows. See LLC vs. S-Corp Election for when that makes sense.

Basis: the number nobody tracks

Each partner has a basis in the partnership, which starts with what they contributed and moves up with their share of income and down with losses and distributions. Basis limits how much loss a partner can deduct and determines whether a distribution is taxable. Almost no small partnership tracks it from the start, and reconstructing it years later, when a partner wants to leave or the business is sold, is expensive. Keep a simple running schedule for each partner from year one.

Texas filings

A partnership operating in Texas generally files a Texas franchise tax report each year, even if it owes nothing, and files the accompanying information report. Most small partnerships fall below the threshold where tax is actually due, but the report is still required and the penalty for skipping it is a forfeiture of the entity's right to do business. The mechanics are in Texas Franchise Tax Explained.

The agreement matters more than people think

A written partnership or operating agreement decides how profits and losses are split, how a partner is paid for services, what happens when a partner leaves, and who has authority to sign. Without one, state default rules and an equal split apply, which is rarely what the owners intended. It does not need to be long. It needs to exist, and the tax return needs to follow it.

What to bring for a partnership return

• The partnership or operating agreement and the EIN letter
• Year-end books: income, expenses, and a balance sheet if the partnership keeps one
• A record of what each partner contributed and what each took out during the year
• Any guaranteed payment arrangement
• Asset purchases with dates and prices
• Prior year return and K-1s, if this is not the first year

We prepare partnership returns for businesses across Weatherford, Willow Park, Granbury and the surrounding counties. Many of them came to us the first time because someone mentioned, a week before the deadline, that a multi-member LLC needs its own return.

This article is general information, not tax advice. Partnership rules, penalties and franchise tax thresholds change, so confirm the details for your own business.

Own a business with someone else? Call RD Precision Tax Service in Weatherford at (817) 480-6649, or request a free estimate. Our small business tax preparation covers the partnership return and each partner's personal return together.