How are partnerships taxed? A founder's guide to Form 1065

Two co-founders form an LLC. They split ownership, open a business bank account, start generating revenue, and assume their taxes work the same way as a salaried employee's. They don't.

A multi-member LLC is a partnership for federal tax purposes unless it has made a specific election to be treated otherwise. That means Form 1065, a separate tax return for the entity, filed every March. And it means every partner receives a Schedule K-1 that determines what they owe individually for the year.

Why partnerships don't pay income tax (but still file a return)

The defining feature of partnership taxation is pass-through treatment. A partnership does not pay federal income tax at the entity level. The IRS taxes partnership income exactly once, in the hands of the partners, not the business.

But the IRS still needs to know how that income is distributed. That is what Form 1065 is for. It is an information return: a document that reports the partnership's total income, deductions, gains, losses, and credits for the year, and then allocates each partner's share of all of those items.

The entity files one Form 1065. Each partner receives a Schedule K-1 from that return, showing their individual share. They carry those numbers onto their personal tax returns.

This is different from a C corporation, which files Form 1120 and pays corporate income tax at the entity level before anything reaches shareholders. Partnerships skip that step entirely. The tax obligation flows straight through.

Who is required to file Form 1065

Per the IRS 2025 instructions, every domestic partnership must file Form 1065 for each tax year it either receives income or incurs expenses that would qualify for deductions or credits. This applies to:

• General partnerships
• Limited partnerships (LPs)
• Limited liability partnerships (LLPs)
• Multi-member LLCs that have not elected corporate tax treatment

The last category is the one founders most frequently miss. A domestic LLC with two or more members is classified as a partnership by default under IRS rules. No election is needed to be treated as a partnership. That is simply what the IRS does with a multi-member LLC that has not filed Form 8832 to elect otherwise. Form 1065 is required.

There is one narrow exception: a qualifying joint venture between a married couple who file jointly may elect out of partnership treatment and each report their share directly on Schedule C. This is uncommon in the startup context but worth knowing exists.

The filing requirement holds even in a year with no revenue. If the partnership incurred deductible expenses, a return is due.

Foreign partnerships

A foreign partnership with income connected to a US trade or business, or with gross income derived from US sources, must also file Form 1065. This applies even if the partnership's principal place of business is outside the United States or all of its members are foreign persons.

There are two exceptions to this rule. A foreign partnership with US partners may skip filing if it had no effectively connected income, its US-source income was $20,000 or less, less than 1% of any partnership item was allocable to US partners at any time during the year, and it is not a withholding foreign partnership. A foreign partnership with no US partners and no effectively connected income may also qualify for an exception if the required withholding tax forms (Forms 1042 and 1042-S) were properly filed.

For a global founder running a US LLC with international partners, these rules are worth reviewing with a tax advisor.

How partnership income is actually taxed

The partnership itself calculates its total income and deductions for the year. That net figure is then divided among the partners according to the partnership agreement. Partners may agree to allocate specific items in a ratio different from the general income-sharing ratio, but those allocations must have substantial economic effect to be respected by the IRS. If an allocation lacks substantial economic effect, or if the agreement does not address a particular item, the IRS determines each partner's share based on their interest in the partnership.

Each partner is then taxed on their allocated share of income, regardless of whether any cash was actually distributed to them. This is a point that catches founders off guard. If the partnership earned $200,000 and your partnership agreement gives you a 50% share, you owe tax on $100,000, even if the business kept all of it as working capital and you received no distribution.

This is sometimes called phantom income: taxable income without a corresponding cash inflow.

Self-employment tax

For general partners and LLC members who are active in the business, the allocated income is typically subject to self-employment tax (15.3% on the first $176,100 of net self-employment income for 2025, plus 2.9% Medicare on income above that threshold). This is separate from income tax and is calculated on Schedule SE.

Limited partners who have no active role in the business are generally not subject to self-employment tax on their allocated share. But the IRS applies this distinction carefully, and founders who are both investors and operators should not assume limited partner treatment without advice.

What is inside Form 1065

Form 1065 has several components. Understanding what each does helps in knowing what records the partnership needs to maintain throughout the year.

Page 1: Income and deductions. The return opens with the partnership's gross income from all sources, then works through deductible expenses: salaries paid to employees (not partners), rent, interest, depreciation, and other ordinary business costs. The result is ordinary business income or loss.

Schedule B: Additional information. This section asks about the partnership's ownership structure, accounting method, whether any partners are foreign persons, and whether the return is subject to the centralized audit regime under the Bipartisan Budget Act of 2017.

Schedule K: Partners' distributive share items. This is the consolidation point. Schedule K pulls together all categories of income, loss, deduction, and credit across the full partnership. It shows the total of each item before any allocation to individual partners. Ordinary income is only one line on Schedule K. Capital gains, rental income, Section 179 deductions, foreign tax credits, and a range of other items are broken out separately because they are treated differently on each partner's individual return.

Schedule K-1: Each partner's share. A separate K-1 is prepared for every partner. It takes their proportionate (or agreed-upon) share of every item on Schedule K and presents it in a format they can carry directly onto their own return.

Schedule L: Balance sheet. A comparative balance sheet showing the partnership's assets, liabilities, and capital at the beginning and end of the tax year.

Schedule M-1: Reconciliation. This reconciles the difference between book income (what the partnership reports in its accounting records) and taxable income. Common differences include depreciation timing, non-deductible expenses, and tax-exempt income.

Schedule M-2: Analysis of partners' capital accounts. Tracks changes in each partner's capital account balance from the beginning to the end of the year.

Smaller partnerships (generally those with under $250,000 in gross receipts and under $1 million in total assets, that file fewer than 100 K-1s) may qualify to check a box on Schedule B that exempts them from filing Schedules L, M-1, and M-2. Confirm current thresholds with the IRS instructions for the relevant tax year.

Schedule K-1: what partners receive and what they do with it

The K-1 is the document that makes partnership taxation personal. It arrives from the partnership after the Form 1065 is prepared, and it tells each partner exactly what to report on their own return.

The K-1 breaks out each partner's share of:

• Ordinary business income or loss (Box 1)
• Net rental real estate income or loss (Box 2)
• Other net rental income or loss (Box 3)
• Guaranteed payments for services (Box 4a), for capital (Box 4b), and total guaranteed payments (Box 4c)
• Interest income (Box 5)
• Ordinary dividends and qualified dividends (Boxes 6a and 6b)
• Royalties (Box 7)
• Net short-term and long-term capital gain or loss (Boxes 8 and 9)
• Net Section 1231 gain or loss (Box 10)
• Other income (Box 11)
• Section 179 deduction (Box 12)
• Other deductions (Box 13)
• Self-employment earnings (Box 14)
• Credits (Box 15)
• Foreign transactions (Box 16)
• Alternative minimum tax items (Box 17)

The reason each category is separated is that they flow to different lines and schedules on the individual return. Ordinary income goes to Schedule E. Capital gains go to Schedule D. Self-employment income goes to Schedule SE. The partnership itself does not choose how any of this is taxed at the individual level. The K-1 just delivers the data, and each partner applies the right treatment on their own return.

This is why the Form 1065 deadline (March 15 for calendar-year filers) precedes the individual filing deadline (April 15). Partners need their K-1 to file their own returns. A late partnership return cascades directly into delayed or inaccurate personal filings for every partner.

Deadlines and extensions

For calendar-year partnerships, Form 1065 is due on March 15 of the following year. If March 15 falls on a weekend or federal holiday, the deadline shifts to the next business day. For the 2025 tax year specifically, the IRS instructions confirm the timely filing date is March 16, 2026, because March 15, 2026 falls on a Sunday.

An automatic six-month extension is available by filing Form 7004 on or before March 15. For calendar-year filers, this extends the filing deadline to September 15.

As with all extensions, this only extends the time to file the return. Any partner-level tax owed for the year is still due on each partner's individual deadline. Partners who rely on a Form 7004 extension for the partnership return should still estimate their individual liability and make payments as needed to avoid underpayment penalties.

Electronic filing requirements

The IRS has expanded electronic filing requirements significantly in recent years. Per current rules, partnerships that file 10 or more returns of any type during the tax year (including W-2s, 1099s, employment tax returns, and information returns) are required to file Form 1065 electronically. Partnerships with more than 100 partners must always file electronically, regardless of total return volume. This requirement has been in the IRS regulations since the Taxpayer Relief Act of 1997, and the IRS's Electronic Management System (EMS) has accepted Form 1065 and all related schedules and K-1s electronically since 2000.

Hardship waivers are available in limited circumstances. Most startup partnerships with any volume of business activity will fall under the mandatory e-file threshold.

Penalties for late filing and missing K-1s

The IRS penalty for a late or incomplete Form 1065 is calculated under Section 6698 of the Internal Revenue Code. For the 2025 tax year, the penalty is $255 per partner, per month, for up to 12 months. The penalty runs from the original due date (or the extended due date if an extension was properly filed), and it applies regardless of whether the partnership owed any tax.

For a four-partner LLC that files two months late, that is $2,040. For a ten-partner entity over the same period, it is $5,100. The scale with partner count is what makes this penalty expensive for even small partnerships.

Separate penalties apply for missing or late Schedule K-1s. Per the 2025 Form 1065 instructions, the IRS may impose a penalty of $340 for each K-1 that is not furnished to a partner on time or that contains incorrect information. The maximum aggregate penalty for all such failures in a calendar year is $1,366,000 for entities with gross receipts at or below $5 million, and $4,098,500 for entities with gross receipts above $5 million. Where the failure is intentional, each $340 penalty rises to $680, and there is no cap on the total.

Reasonable-cause relief is available in genuine cases, but the partnership must document why the failure to file was beyond its control. Late relief is not automatic.

Guaranteed payments

One element of partnership taxation that founders often underestimate is guaranteed payments. A guaranteed payment is compensation paid to a partner for services rendered or for use of capital, without reference to the partnership's income. Think of it as a partner-level salary analog.

Guaranteed payments are deductible by the partnership and appear on Schedule K. On the recipient's K-1, the 2025 instructions distinguish between Box 4a (guaranteed payments for services), Box 4b (guaranteed payments for capital), and Box 4c (total guaranteed payments). For the recipient partner, they are ordinary income and are subject to self-employment tax. This is different from a simple profit distribution, which is not a guaranteed payment and is not separately deductible.

If a founding team has structured any partner compensation as guaranteed payments, that needs to be properly documented in the partnership agreement and correctly reported on the K-1s.

How Inkle handles Form 1065

For founders at a multi-member LLC or partnership, Form 1065 is a real compliance obligation with real deadlines and real penalties. Most early-stage founding teams do not have a dedicated finance person whose job it is to track these things.

Inkle prepares and files Form 1065 for US partnerships and multi-member LLCs, including generating Schedule K-1s for each partner. Because Inkle's bookkeeping and tax products run on the same underlying ledger, the data that flows into the partnership return is the same data that has been categorized, reconciled, and closed every month. Not reassembled from a spreadsheet at the deadline. That means fewer errors, faster preparation, and a return that is already consistent with the books.

Inkle's Form 1065 filing is $350 per year. That covers the full partnership return, all K-1s, and coordination with each partner so their individual filings reflect the correct numbers.

For partnerships with foreign partners, intercompany transactions, or cross-border complexity, Inkle's tax team handles the additional reporting layers without the partnership needing to manage multiple advisors.

The quiet result

Partnership taxation is not complicated in principle. Income flows through, each partner pays tax on their share, and the return documents how that allocation was made.

Where it gets complicated is in the execution: tracking each partner's capital account correctly, reconciling book income to taxable income, issuing K-1s before individual filing season, and meeting a March 15 deadline that most founders don't have circled. Getting these things right protects every partner's ability to file their own return accurately and avoids a penalty structure that scales directly with the number of people on your cap table.

File the return. File it on time. Get the K-1s out before your partners need to file their own returns.

Frequently Asked Questions

Do partnerships pay federal income tax? 

No. Partnerships are pass-through entities. The partnership itself pays no federal income tax. Instead, each partner's allocated share of income, deductions, and credits flows through to their individual return via Schedule K-1. The partnership files Form 1065 as an information return to document how income is allocated.

What is the difference between Form 1065 and Schedule K-1? 

Form 1065 is the partnership's annual return filed with the IRS. It reports total partnership income, deductions, and other items, then allocates each partner's share. Schedule K-1 is the individual document each partner receives from that return, showing their specific allocated amounts to report on their personal tax return.

When is Form 1065 due? 

For calendar-year partnerships, Form 1065 is due March 15. An automatic six-month extension is available by filing Form 7004 before that date, moving the deadline to September 15. The extension covers filing time only. Partner-level tax owed for the year is not extended.

What happens if a partnership files Form 1065 late? 

For the 2025 tax year, the IRS charges $255 per partner, per month, for up to 12 months. Separately, failing to furnish Schedule K-1s on time can add a $330 penalty per K-1. Both penalties apply regardless of whether the partnership owed any tax.

Does a multi-member LLC have to file Form 1065? 

Yes, unless it has elected to be taxed as a corporation using IRS Form 8832. A multi-member LLC with no such election is classified as a partnership by default and must file Form 1065 each year.