Form 1065 is a federal income tax form used to report revenue and expenses from the operation of a partnership. If you are a partnership or a multimember LLC, you might need to complete Form 1065 and the associated Schedule L when submitting your annual business taxes. A tax professional can help you determine whether this form is necessary for your company.
Who Uses Schedule L?
Partnerships and multimember LLCs taxed as partnerships are not subject to federal income tax. Instead, they are taxed on a "pass-through" basis. Partnerships pass profit through to the partners based on ownership share, and the partners then declare this profit as income on their individual returns.
What Is Form 1065 Schedule L?
This is where Form 1065 comes in. The pass-through profits and losses of a business are reported on Schedule K-1, and Schedule L is used to detail the partnership's balance sheet for the IRS. The form is due on the 15th day of the fourth month following the partnership's year end.
If you need a little more time to balance your books, partnerships can also request an automatic five-month extension by filing Form 7004 by the same due date.
Start With Schedule K-1
Before you get to looking at Schedule L, it's important to go through Schedule K-1. Schedule K-1 is used to report each partner's share of the partnership income, credits, earnings, losses and deductions. While partners in a partnership generally receive a payout of the profits in the form of a capital distribution, another way partners receive money from partnerships is by guaranteed payments.
If a partnership fails or is not profitable for some time, it's possible for partners to receive no distributions from their share of the partnership. This can be bad news for partners who make significant investments of time or money in the partnership.
All About Guaranteed Payments
Guaranteed payments are a way to protect partners who bring value to the partnership and provide them with a steady stream of income. These payments are made without regard to the partnership's income or profitability, functioning as a sort of salary for the relevant partner and possibly being subject to self-employment tax on the partner's return.
In terms of what this means for the partnership, guaranteed payments are deducted as a business expense. They are reflected on Line 10 of Form 1065 and then reported on the respective partner's K-1.
Do I Need to Fill Out Schedule L?
The first thing to do when looking at filling out Schedule L is to determine whether you have to complete it in the first place. Schedule L is not required for all partnerships; you only have to file it if you don't meet certain conditions. These are outlined in Schedule B Line 4:
- Total receipts: Did your partnership have less than $250,000 in gross receipts during the year?
- Total assets: Did your partnership's assets at the end of the year total less than $1 million?
- Timely filing of Schedule K-1: Are you filing Schedule K-1 with the return, and did your partnership furnish K-1s to all its partners on or before the due date for the partnership's return (including any extensions)?
- Not filing Schedule M-3: Is your partnership not filing and not required to file Schedule M-3? Schedule M-3 is used for net income reconciliation. In terms of filing Form 1065, Schedule M-3 is required when a partnership has total assets of more than $10 million, has total receipts of more than $35 million or owns at least a 50% share of another partnership that is itself required to file an M-3.
If you can answer "yes" to ALL of these four questions, then you don't have to file Schedule L. However, if the answer is "no" to even one of these conditions, that means it's time to break out the balance sheets and fill out Schedule L.
What You Need to Complete Schedule L
The most important thing you need when completing Schedule L is a well-kept balance sheet for your partnership. A balance sheet is a financial snapshot of a business. It details all the assets and liabilities of your partnership at the beginning and end of the year.
The idea of "balance" refers to the principle that your assets must equal your liabilities plus partners' equity (also called partners' investment or partners' capital accounts). This should already be reflected in your balance sheet. If it's not, then it's a good time to file for an extension and take the time to make sure your balance sheets are in order.
Purpose of Schedule L
The purpose of Schedule L is to show the IRS this financial snapshot of your partnership, which generally entails a relatively straightforward transfer of information from your balance sheets to the form.
Schedule L uses a standard balance sheet format following basic accounting principles. You must enter both a beginning total — column (a) or (b) — and an ending total column (c) or (d). Keep in mind that the method of accounting your partnership uses — generally cash or accrual — may impact what you enter on Schedule L.
Assets on Schedule L
For your assets, you will need to account for all cash and cash equivalents, accounts receivable, inventories, investments, land and loans made to other individuals or businesses. Keep in mind that Schedule L provides space to subtract your bad debt allowance and accumulated depreciation, depletion and amortization.
Your bad debt allowance represents the reserve or allowance you've made to account for the fact that some clients just won't pay, so some accounts receivable will not be collected after all. Depreciation applies to property such as buildings, vehicles and machinery. For intangible assets, include the accumulated amortization.
If your partnership owns any U.S. Treasury notes or bonds or any other debt instrument guaranteed by the full faith and backing of the United States, these are considered to be risk-free assets. State these separately on Schedule L. For any assets not covered in this portion of Schedule L, enter the total dollar value on Line 13 and attach an itemized supporting statement.
Liabilities on Schedule L
Your liabilities include accounts payable, mortgages and loans to the partnership and capital held by the individual partners. Mortgages are divided into those due in the next 12 months and those due farther out. When listing loans made to the partnership, keep in mind that this is for non-recourse loans only, meaning that individual partners are not liable or held personally responsible for these obligations.
There is also a separate line for loans from partners or persons related to partners. There's an "other liabilities" section similar to the "other assets" one. "Other liabilities" not due within 12 months should be totaled here with an itemized statement attached.
Partners’ Capital on Schedule L
The partners' capital should match several other parts of Form 1065. The beginning capital accounts entered in Schedule K-1, Part II, Item L should match what you put in Line 21, Column (b) of Schedule L. The ending balance entered in Line 21, Column (d) of Schedule L should match the amount calculated on Schedule M-2 Line 9 (analysis of partner's capital accounts).
Finalizing Schedule L
The total liabilities and capital are added on Line 22. When the balance sheet is completed, the amounts reported here should match those reported in total assets.
Make sure all your numbers match, and you're done with Schedule L. While the IRS will accept a return filed with a Schedule L that does not balance, this still indicates that something's wrong with the return, with your partnership's books or with both. This is a good time to review your records and consider an extension.
Filling out Schedule L can seem daunting at first. If you have a little trouble with record keeping, Schedule L provides some great guidance on how to go about it. If you already have good balance sheets, you will be off to an excellent start.