Form 1065 (U.S. Return of Partnership Income) 2010
Tax Year Checklist
Overview
Form 1065 reports the income, deductions, gains, losses, and credits from the operation of a partnership. For tax year 2010, the form incorporates significant changes, including new business credits introduced by the HIRE Act, enhanced small employer health insurance credits, therapeutic discovery project credits, and Section 108(i) discharge-of-indebtedness deferrals. Partnerships must also comply with Schedule M-3 filing requirements when total assets equal or exceed $10,000,000.
Key 2010 Tax Year Changes
HIRE Act Credits
The Hiring Incentives to Restore Employment Act, enacted on March 18, 2010, provides credits for wages paid to previously unemployed workers hired after March 18, 2010. Qualifying partnerships must attach Form 5884-B to claim the New Hire Retention Credit.
Section 108(i) Deferrals
Section 108(i) permits partnerships to defer cancellation-of-indebtedness income for qualifying debt reacquisitions occurring in 2009 and 2010. Partnerships electing this deferral must attach a detailed statement identifying each applicable debt instrument, including the issuer name and taxpayer identification number, debt description, principal amount, reacquisition date, and COD income amount.
Passive Activity Grouping Disclosure
Effective January 25, 2010, partnerships grouping multiple activities for the first time must file a written disclosure statement with Form 1065. The statement must list names, addresses, and employer identification numbers of all grouped activities and include an attestation that the grouped activities together constitute an appropriate economic unit under Treasury Regulation 1.469-4(c)(1).
Schedule M-3 Requirement
For tax year 2010, partnerships with total assets of $10,000,000 or more as of December 31, 2010, or total receipts of $35,000,000 or more during the year, must file Schedule M-3 (Net Income Reconciliation) instead of the simplified Schedule M-1.
Step-by-Step Filing Process
Step 1: Verify Partnership Registration and EIN
Confirm the partnership has a valid Employer Identification Number and verify the business formation date. Obtain a copy of the partnership agreement and all amendments effective through December 31, 2010.
For qualifying joint ventures between spouses filing jointly, determine whether a Section 761(f) election was made. If the election is in effect, each spouse should file Schedule C instead of the partnership filing Form 1065.
Step 2: Gather Partner Documentation
Collect the name, address, Social Security Number or Employer Identification Number, and ownership percentage for each partner at any time during 2010. Document all capital contributions, withdrawals, loans to or from the partnership, and guaranteed payments made during the year.
Record any changes in ownership interests that occurred during 2010. For limited partners, verify whether they received guaranteed payments for services, as these amounts affect self-employment income calculations.
Step 3: Collect Income and Investment Documents
Gather all Forms 1099-B (Proceeds from Broker and Barter Exchange Transactions), 1099-DIV (Dividends and Distributions), 1099-INT (Interest Income), 1099-K (Payment Card and Third Party Network Transactions), and 1099-MISC (Miscellaneous Income) received in 2010.
Obtain Schedules K-1 from lower-tier partnerships, S corporations, estates, and trusts in which the partnership holds interests. These schedules report the partnership’s distributive share of income, deductions, and credits from other pass-through entities.
Step 4: Document Section 108(i) Elections
If the partnership reacquired any debt instruments in 2009 or 2010 and elected to defer cancellation-of-indebtedness income under Section 108(i), prepare a comprehensive statement for attachment to Form 1065.
The statement must identify each applicable debt instrument with the following information: name and taxpayer identification number of the issuer, detailed description of the debt instrument, principal amount at issuance, reacquisition date, and the amount of cancellation-of-indebtedness income being deferred.
This election allows partnerships to defer recognition of COD income over five years beginning in the fifth taxable year following the reacquisition year, providing significant cash flow relief during the economic recovery period.
Step 5: Compile Depreciation and Section 179 Records
Gather prior-year depreciation schedules showing the cost basis, date placed in service, accumulated depreciation, and business-use percentage for all depreciable assets. Document all assets acquired during 2010, including purchase date, cost, and business-use percentage.
Calculate the Section 179 expense deduction available for 2010. The maximum deduction is $500,000, reduced dollar-for-dollar by the amount by which the cost of Section 179 property placed in service during 2010 exceeds $2,000,000.
Report Section 179 deductions separately on Schedule K (partnership’s distributive share items) and allocate to each partner in Box 12 of Schedule K-1. Partners then report their allocated share on their individual Form 4562. The partnership does not net Section 179 expense against depreciation on the ordinary business income calculation.
Step 6: Prepare Passive Activity Grouping Disclosure
If the partnership groups multiple activities for the first time in 2010, prepare and attach a written disclosure statement to Form 1065. The disclosure requirement applies to groupings made on or after January 25, 2010.
The statement must list the names, addresses, and employer identification numbers of all activities being grouped. Include an attestation that the grouped activities together constitute an appropriate economic unit under the factors specified in Treasury Regulation 1.469-4(c)(1), which consider similarities and differences in types of trades or businesses, extent of common ownership, geographical location, and interdependencies between activities.
Step 7: Calculate Total Assets for Schedule M-3 Threshold
Determine the total assets reported on Schedule L (Balance Sheets per Books), line 14, column (d), as of December 31, 2010. If total assets equal or exceed $10,000,000, or if total receipts for the tax year equal or exceed $35,000,000, the partnership must complete and attach Schedule M-3 instead of Schedule M-1.
Schedule M-3 provides a more detailed reconciliation of net income (loss) per the books with income (loss) per the return, requiring partnerships to identify temporary and permanent book-tax differences with greater specificity.
If the partnership does not meet either threshold, complete the simplified Schedule M-1 (Reconciliation of Income (Loss) per Books With Income (Loss) per Return).
Step 8: Document New 2010 Credits
If the partnership qualifies for the New Hire Retention Credit for workers hired after March 18, 2010, complete and attach Form 5884-B. The credit applies to wages paid to qualified employees who were unemployed or worked fewer than 40 hours during the 60 days ending on the date of hire.
If eligible for the Small Employer Health Insurance Premium Credit, complete and attach Form 8941. This credit helps small employers offset the cost of health insurance coverage for their employees. The partnership calculates the credit and allocates it to partners in proportion to their distributive shares.
If claiming the Qualifying Therapeutic Discovery Project Credit, complete and attach Form 8942. This credit requires certification from the IRS and applies to qualified investments in therapeutic discovery projects aimed at developing new therapies to address areas of unmet medical need.
Attach all required supporting documentation as specified in the instructions for each credit form.
Step 9: Complete and Assemble Form 1065
Prepare Form 1065, pages 1 through 5. Page 1 reports ordinary business income or loss.
Complete Schedule K (Distributive Share Items), which summarizes the partnership’s total income, deductions, credits, and other items that must be separately stated and allocated to partners.
Prepare Schedule K-1 (Partner’s Share of Income, Deductions, Credits, etc.) for each partner. Each Schedule K-1 reports the partner’s distributive share of income, deductions, credits, and other items.
Complete Schedule L (Balance Sheets per Books) and Schedule M-2 (Analysis of Partners’ Capital Accounts) if the partnership maintains books and records. Attach Schedule M-1 if total assets are under $10,000,000 and total receipts are under $35,000,000. Otherwise, attach Schedule M-3.
If the partnership has capital gains or losses, complete and attach Schedule D (Capital Gains and Losses). Include any other required schedules for alternative minimum tax items, self-employment earnings adjustments, and other separately stated items.
Step 10: Sign, File, and Distribute
A general partner or LLC member manager must sign and date Form 1065. The signature certifies that the return is accurate, correct, and complete to the best of the signer’s knowledge and belief.
File Form 1065 by the 15th day of the 4th month following the close of the tax year. For calendar-year partnerships, the 2010 return is due by April 15, 2011. Partnerships may request an automatic five-month extension by filing Form 7004 before the original due date.
Submit the completed return to the appropriate IRS service center based on the partnership’s principal business location. Provide each partner with a copy of their Schedule K-1 by the filing deadline.
Failure to timely file Form 1065 results in a penalty of $89 per month (or part of a month) per partner, up to a maximum of 12 months. The total penalty equals $89 multiplied by the number of months late, multiplied by the number of partners during any part of the tax year.
Failure to furnish Schedule K-1 to each partner by the due date incurs a penalty of $50 for each failure, up to a maximum of $100,000 per calendar year. If the failure results from intentional disregard, the penalty increases to $100 per Schedule K-1 (or 10% of the aggregate amount of items required to be reported, if greater), with no maximum limit.
Form-Specific Requirements and Limitations
Foreign Partnerships and Foreign Partners
A foreign partnership not created or organized in the United States must file Form 1065 if it has any U.S. source income or is otherwise required to file under Internal Revenue Code Section 6031. Foreign partners report their distributive share on Schedule K-1 and may be subject to withholding on U.S.-source income under applicable withholding provisions.
Nonrecourse Debt Reporting
The partnership must identify nonrecourse liabilities on Schedule L and allocate them among the partners in accordance with Section 752 of the Internal Revenue Code. Nonrecourse liabilities are loans for which no partner bears the economic risk of loss. Qualified nonrecourse debt secured by real property increases a partner’s at-risk basis for Section 465 purposes, allowing greater loss deductions than general nonrecourse debt.
Self-Employment Income
General partners must include their distributive share of ordinary business income in self-employment earnings on Schedule SE (Self-Employment Tax). Limited partners report only guaranteed payments received for services rendered as self-employment income. The distributive share of limited partners is generally not subject to self-employment tax unless it constitutes payment for services.
Guaranteed payments to partners for services or the use of capital reduce the partnership’s ordinary business income and are separately stated on Schedule K and each partner’s Schedule K-1.
Capital Gains Allocation
The partnership must separately report capital gains and losses by holding period (short-term versus long-term) on Schedule D and Schedule K-1 using appropriate identification codes. Partners cannot recharacterize these items on their individual returns. The character of gains and losses flows through from the partnership level to the partner level.
Short-term capital gains and losses are reported separately from long-term capital gains and losses. Section 1231 gains and losses from the disposition of specific business property are also separately stated.
Passive Activity Loss Limitations
Passive activity losses are limited to passive activity income at the partner level. Each partner must complete Form 8582 (Passive Activity Loss Limitations) to calculate the deductible amount of passive losses. Partners who actively participate in rental real estate activities may qualify for a special $25,000 allowance, which permits the deduction of up to $25,000 of rental real estate losses against non-passive income, subject to modified adjusted gross income phase-out rules.
This allowance begins to phase out when modified AGI exceeds $100,000 and is completely phased out at $150,000. Excess passive losses that cannot be deducted in the current year carry forward indefinitely to future years when the partner has sufficient passive income or disposes of the entire interest in the activity.
Section 179 Expense Deduction
For 2010, the maximum Section 179 expense deduction is $500,000, reduced dollar-for-dollar by the amount by which the cost of Section 179 property placed in service during the year exceeds $2,000,000. Once the cost of qualifying property reaches $2,500,000, no Section 179 deduction is available.
The partnership allocates the Section 179 deduction to partners in proportion to their distributive shares. Each partner’s allowable deduction is subject to limitations based on the partner’s taxable income from all trades or businesses. Any excess Section 179 expense carries forward to subsequent years.
Record Retention
Maintain all partnership books and records, including the partnership agreement, financial statements, tax returns, supporting schedules, and documentation for all income, deductions, credits, and distributions. Maintain records that support asset basis, depreciation calculations, and capital account balances to ensure accurate financial reporting.
The general statute of limitations requires retaining records for at least three years from the due date of the return or the date filed, whichever is later. If the return contains underreported income exceeding 25% of gross income, the statute extends to six years. If no return is filed or a fraudulent return is filed, records should be retained indefinitely.
Keeping your records organized helps you prepare future tax returns correctly, provides proof if the IRS checks your information, and makes it easier to track partnership basis, capital accounts, and carry-forward items.
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This checklist is for educational purposes only and does not constitute tax or legal advice. Always review official IRS instructions and consult a qualified professional for guidance.
