LLC Partnership Tax Basis & Basics: Form 1065, Sch K-1, Capital Account, Inside Basis, Outside Basis

in this video I'm gonna break down partnership taxation basics and basis which is a common concept for partnerships so I'll be explaining how a partnership is taxed and how to keep partnership accounting records because that's what gives you the information you need for taxes and all of this will lead us right into what the multi-member LLC or partnership business needs to keep track of itself and what individual partner members need to keep track of on their own because the business won't be doing it for them if you've been confused by what you find online I don't blame you there's a lot of technical textbook type examples which tend to be disconnected from reality I'll be showing you my partnership worksheet calculation in Excel which compares the three types of member partner basis calculations which I'll be explaining more momentarily and we'll be looking at my multi-member LLC business spreadsheet template now like many things taxes the partnership taxation is quite complex but I'll be explaining the differences between inside and outside basis capital account tax basis so if you've been hearing these terms when you're trying to figure out your partnership taxation I'll be clarifying the differences in this video now I do have other videos that will go through the individual calculations the differences and paying yourself and you'll find the links to those in the description below however I highly recommend watching this video first my name is Amanda you're watching the business finance coach on YouTube where I simplify business to help small business owners succeed I'm the creator of the small business MBA which is an online program that helps business owners step-by-step to set up their LLC their business accounting taxes and legality all in one online II course I give away a free version of the spreadsheet template that's in that course called the free business spreadsheet template if you need help with accounting quarterly taxes and end-of-year taxes all covered in there so there's links in the description below to everything I just mentioned for now let's get back to partnership taxation first let's just go over who exactly partnership taxation is for we have legal business types of multi-member LLC s meaning there's two or more members and partnership businesses now both of these types of businesses default to be taxed as a partnership now if they qualify they can elect to be taxed as a corporation and then text as an escort and an S Corp combines aspects of the corporation and a partnership and it's really a common tax type so how is a partnership text a partnership is called a flow-through entity because the activity from the business flows through to the partners and so the business itself pays no taxes and this happens on form 1065 which is the businesses tax form the business form reports all of the businesses activity income expenses other income other deductions and that all of these amounts flow through on to schedule K ones and there's a schedule k-1 for each partner attached to the form 1065 so all of the activity is reported to the partners based on their ownership percentage each business has a hundred percent ownership share which it can allocate between its owners so all of the amounts on the schedule K ones need to add up to the amount on the 1065 just like all of the partners ownership percentages need to add up to a hundred percent for the business then each partner reports their schedule k-1 on their personal form 1040 for their taxes that means that the business must file before the partner can file their own personal tax form they report the schedule k-1 just like they would a w-2 or a 1099 however that's where things get more complicated because unlike a 1099 which has one number the schedule k-1 will have often many different numbers because it's related to the business activity when that business activity flows through to the K ones it retains its character that's a tax phrase which means if the income was interest income for the business its interest income for the partner on their personal return if the income was rental income then it's rental income on the partners return so let's flip over to form 1065 and schedule k-1 and I'll show you what this looks like form 1065 u.s. return of partnership income so this page one reports what the business actually does so this is going to be the ordinary business net income or loss the income is reported on top and the expenses reported on the bottom that gets us down to this ordinary income or loss line 22 now you'll notice this income doesn't include things like investments dividends or interest sales of things this is only for what the business is in the business of doing that's why there's costs of goods sold gross profit ordinary income or loss now down here are the expenses we have salaries and wages first and that refers to w-2 employees but that does not include any payments to the partners because partners which could be members in an LLC are never taxed as w-2 employees now if they're receiving a regular payments that like a salary that's under guaranteed payments to partners which is a deduction for ordinary business income however I don't want you feeling like that's a deduction in a better way to do things because at the end of the day it doesn't actually make a difference and I'll go into more detail in that in my video about paying yourself in a partnership many expenses will just go under other deductions with an attached statement if they don't fit into any of the other categories so that gets us to ordinary business income or law and a lot of people see this tax section at the bottom and get confused these are not taxes that are often applicable to partnerships so that's the main business activity now page 2 and page 3 are just based on informational questions page 4 is schedule K and this is where everything is divided out and it's from schedule K that all of the information flows to the K ones so we can see that final net income or loss from page 1 line 22 it's reported first but then we have two other main types of income net rental real estate income or loss or other gross rental income or loss so if you have amounts in more than one of box 1 2 or 3 then you should have additional statements attached to your partnership tax return that explain how the any activity listed below is related to these different activities essentially it would have made more sense for them to just require a separate schedule K to be used for each activity box 1 2 & 3 these are the three main activities for partnership net income or loss then we have these called separately stated items we can see there's interest income dividends capital gains sale of business assets that's section 1231 property section 179 deduction is a special type of depreciation contributions means charitable contributions so the business doesn't take it instead it goes to your own personal return to see if that partner will qualify for those charitable contributions are not investment interest expense that was a schedule a deduction net earnings are lost from self-employment and this is where the taxes really come into play again be sure to check out my being paid in a multi-member LLC partnership video so these are other less-common items down below here and then these last are just informational as far as the categories page five of 1065 is not required for small businesses very small businesses but once it is required it does bring on a level of complexity essentially the purpose of this page is a check from your book accounting records based on tax changes to get to your tax numbers and it includes looking at the partner accounts it includes looking at the balance sheet both book bases to tax basis at the beginning and end of the year and then reconciling okay what was your net income on the books let's account for all those tax changes and then get to net income or loss on the return and then same thing with the partner capital accounts so that brings us over to schedule k-1 this is the form that each partner gets and that there's one attached to the set 1065 filed with the IRS for each partner as well part three here is where all of those schedule k items are being reported to the partner often under many of these blocks you'll see multiple lines and that's where there can be a letter in the box that indicates the type of amount to the right of it and on page two you'll see there's codes for what the letters mean in different boxes so for line 11 code a means other portfolio income codes c means section 12 56 contracts and straddles how is partnership accounting handled so all multi-member LLC and partnership legal businesses they must for both legal purposes and tax purposes keep a complete and accurate record of everything that happens in the business that affects value now this record should be maintained daily and should include everything that happens in the business that affects value this is my accounting spreadsheet template for multi member LLC's you can see on the income statement there's an area for everything that's increasing the bank account and then an area for everything decreasing in the bank account of course commonly we have income sections and expense sections to know how profitable the business is but there's also a line for each partner or member in the business so that we can track any money they put into the business account and any money they take out of the business account that's not a guaranteed salary payment so all of that activity is affecting that partners account now the next main point of accounting records is called the balance sheet it's a report it's really the highest level report for a business that represents everything happening in the accounting records for that business the balance sheet which shows assets equals liabilities plus owner's equity now that's an equation that is always true for business accounting records that are kept correctly so have assets are everything the business owns is equal to liabilities everything the business owes plus the owner's equity section and this is our first category of calculation for the member partners in a business for a partnership taxation so let's zoom into that section so here we have the owner's equity section and we can see that there's owner capital and then we have retained earnings and this is the net income from each period which is coming from our income statement total revenue minus total business expenses gives us net income so the income statement is based on a period of time right with where as the balance sheet is based on one day as of today this is the value of the business so the capital accounts essentially account for increases to the bank account anything that the business owners put in and anything the business owner is taking out and that's what the capital account is however if we flip back to our schedule k-1 we have the partners capital account analysis and so this is essentially coming from the accounting records that partners capital account however our current year increases or decreases are going to come from that retained earnings section so although retained earnings is not allocated to the partner accounts in the accounting records it is done so on the schedule a partner's capital account analysis here under Section L but where confusion comes in in understanding these three calculations is that this first option is tax basis which is what most small businesses are going to check however the next two calculations that we're going to learn about for partner members are often also referred to as a tax basis next let's go into basis and what the next two calculations are for members what is a partnership basis the word basis is a common tax term that means your investment value in any asset an asset is anything that you own so whether it's a real estate property stocks or a percentage of a partnership business what you paid for that asset is your basis or your investment in that asset then as you go throughout the year as activities happen income and expenses have occur these different things will affect the basis by increasing it or decreasing it based on the specific rules for that type of asset so there are different rules for stock for rental properties and for business partnership percentages of course so when you initially purchased an asset you start with the beginning basis amount and this often starts at zero or cost basis which is what you paid for it when the ass that is sold whatever the adjusted basis is at that point in time you will take the sale price including everything you effectively receive doesn't have to be cash - everything you gave up which is your adjusted basis and if everything you got was more than what you gave up you have a gain if it's the other way you have a loss partnership basis works essentially the same way a partner owns a share of the business for whatever cash services or assets that they contributed for that portion now cash is the only straightforward one so we'll use that as an example if someone put $10,000 into the business in exchange for their 50% share then they own 50% of the business with a starting basis of $10,000 however this is where it immediately gets more complicated because with a partnership we actually have two perspectives we have the businesses perspective and how the business treats things and we have the partners perspective in their individual investment in the business so the businesses perspective is our second calculation which is called inside basis because it's inside the business and so this is a basis investment calculation based on the business allocating the assets to the partners then the outside basis is what each partner needs to keep track of on their own for their investment in the business let's jump into the basis calculation worksheet here we are in the partnership basis calculation worksheet and one concept to understand is that partners have to pay tax on their share of the net business income that ordinary partnership business income regardless of how or if it's actually distributed to the partners and so that's where a lot of the nuances of these basis calculations really comes in because it prevents manipulation of taxes essentially prevents people from avoiding taxes so this spreadsheet is to illustrate the basis concepts of outside and inside basis and the capital account so the concept of inside and outside basis it is similar starts with beginning balance ads this section of increases that gives us beginning balance plus increases then minus decreases and that gives an ending balance and basis is calculated each period usually a year so outside basis this column is each partner's personal basis their investment in their share of the business and then in site basis on the other hand is essentially the allocation of the value of the business to its partners and remember the capital account alternatively is just based on the accounting records and is primarily based on contributions and withdrawals so if we look at the inside basis tab we can see that we have a column for each partner because remember this is from the businesses perspective allocating all of the assets and value to the partners I'll be doing more detailed videos on these calculations well that's all guys to review we covered partnership taxation we went into the actual tax forms we went into how to be accounting and then we looked at the capital account for a partner as well as inside basis and outside basis remember I have other videos that go into more detail about these areas don't forget about my free spreadsheet if you're interested in that otherwise a lot of links to other videos in the description below thanks for joining me do subscribe if you're new here and you want to be notified when I post new videos I'd love to hear from you in the comments below if you have questions and otherwise I'll see you next time bye

Channel: Business Finance Coach

Views: 50,175

Keywords: Partnership Taxation basics, Partnership tax basis, partnership tax basics, llc partnership taxes, form 1065 partnership, partnership taxation basis, partnership llc taxes, capital account schedule k-1, schedule k-1 capital account analysis, inside basis vs outside basis, inside basis vs outside basis partnership, form 1065 for LLC, schedule k-1 explained, accounting spreadsheet for small business, understanding balance sheet and income statement, tax basis

Id: rPXhgqNc5-k

Length: 19min 59sec (1199 seconds)

Published: Mon Aug 19 2019