Form 1065 for Tax Year 2020: IRS-Accurate Compliance Checklist and Instructions
Overview of Form 1065 for Tax Year 2020
Form 1065, U.S. Return of Partnership Income, is an information return used to report the income, gains, losses, deductions, and credits from the operation of a partnership. The partnership itself does not pay income tax. Instead, it passes through profits or losses to its partners, who must report their share on their individual or business tax returns.
For tax year 2020, partnerships must comply with specific filing requirements, deadlines, and reporting obligations, including significant changes to partner capital account reporting and considerations for COVID-19 relief provisions. This checklist provides step-by-step guidance to ensure accurate and timely filing.
Key Updates and Special Provisions for 2020
Mandatory Tax Basis Capital Account Reporting
Beginning with tax year 2020, partnerships are required to report partner capital accounts on Schedule K-1, Item L, using the tax basis method. This represents a significant change from prior years, when partnerships could report capital accounts using book basis or other methods. The tax basis method is a transactional approach that tracks each contribution, distribution, share of income, and share of loss affecting a partner’s capital account.
For partners who did not use tax basis in 2019, partnerships must compute the beginning 2020 capital account using one of three IRS-approved transition methods: the Modified Outside Basis Method, the Modified Previously Taxed Capital Method, or the Section 704(b) Method. Partnerships must include a statement identifying which method was used for the transition.
CARES Act and FFCRA Relief Provisions
Partnerships claiming Families First Coronavirus Response Act paid sick leave or family leave credits for wages paid from April 1 through December 31, 2020, must exclude those wages from deductible salary line items and report the credits separately. These credits apply only to wages paid during the specified 2020 period.
Partnerships with qualifying employees affected by COVID-19 government suspension orders or experiencing significant gross receipt declines in 2020 may claim the Coronavirus Aid, Relief, and Economic Security Act Employee Retention Credit. Wages used to claim the Employee Retention Credit cannot be included in the wage deduction claimed on line 9 of Form 1065.
Section 163(j) Business Interest Limitation
Partnerships with business interest expense must calculate the limitation at the partnership level. Deductible business interest cannot exceed the sum of business interest income, 30 percent of adjusted taxable income, and floor plan financing interest. Disallowed business interest expenses must be allocated to partners as a separate item on Schedule K and Schedule K-1 using Code N in box 20.
Step-by-Step Compliance Checklist
Step 1: Determine Filing Requirement and Partnership Identity
Confirm the partnership is domestic, meaning it was created or organized in the United States. If the partnership is foreign, verify that it has U.S. source income or effectively connected income that requires Form 1065 filing. Foreign partnerships may qualify for filing exceptions if they meet specific criteria, including having no effectively connected income, U.S. source income of $20,000 or less, and less than 1% of partnership items allocable to direct U.S. partners.
Enter the partnership name, employer identification number, address, and tax year on the form. Verify the entity is classified as a partnership and not a trust, disregarded entity, or S corporation. File Form 1065 only if the partnership received income or incurred deductible expenses or is making a section 754 election or qualified opportunity fund election on Form 8996.
Step 2: Gather Income Documents and Confirm Accounting Method
Collect all Forms 1099-NEC, 1099-MISC, 1099-DIV, 1099-INT, Schedules K-1 from lower-tier partnerships, and bank statements. Confirm that the partnership uses a consistent cash, accrual, or other permissible accounting method. Report the accounting method in item H on page 1 of Form 1065.
If using the accrual method, verify compliance with section 448 rules. Document current-year gross receipts, as partnerships with gross receipts exceeding certain thresholds must comply with section 163(j) business interest limitation rules and may face different accounting method requirements.
Step 3: Calculate Gross Profit and Complete Form 1125-A if Applicable
Enter gross receipts or sales on line 1a and subtract returns and allowances on line 1b to determine net receipts on line 1c. If the partnership maintains inventory or has cost of goods sold, complete and attach Form 1125-A, Cost of Goods Sold. Enter the cost of goods sold from Form 1125-A on line 2 of Form 1065.
Calculate gross profit by subtracting the cost of goods sold from net receipts. Enter the result on line 3. Form 1125-A is required for partnerships that report cost of goods sold.
Step 4: Report Ordinary Business Income and Other Income Items
Add ordinary income from other partnerships, estates, and trusts on line 4. Include net farm profit or loss from Schedule F on line 5 and net gain or loss from Form 4797 on line 6. Report other income or loss items on line 7, including any FFCRA paid leave credits if the partnership is the eligible employer claiming the credit.
Combine all income amounts from lines 3 through 7 to determine total income on line 8. Ensure proper documentation and categorization of each income source to maintain accurate records.
Step 5: Deduct Salaries, Guaranteed Payments, and Operating Expenses
Report salaries and wages paid to employees on line 9, excluding employment credits and wages used to claim the Employee Retention Credit. Enter guaranteed payments to partners on line 10. Report ordinary operating deductions, including repairs and maintenance, bad debts, rent, taxes and licenses, and interest on lines 11 through 15.
If claiming depreciation, complete and attach Form 4562, Depreciation and Amortization. Enter total depreciation on line 16a. Subtract any depreciation already reported on Form 1125-A and enter the result on line 16c. Business interest expense is reported on line 15 and may be subject to the section 163(j) limitation.
Enter depletion on line 17, excluding oil and gas depletion, which each partner must calculate separately on their individual return. Report contributions to retirement plans and employee benefit programs on lines 18 and 19. Enter other deductions on line 20 and total all deductions on line 21.
Step 6: Apply Section 163(j) Business Interest Limitation at Partnership Level
Calculate the business interest expense limitation at the partnership level. Deductible business interest cannot exceed the sum of business interest income plus 30 percent of adjusted taxable income plus floor plan financing interest. If section 163(j) applies and business interest expense exceeds the limitation, allocate the disallowed amount as a separate item to partners on Schedule K and Schedule K-1.
Report disallowed business interest expense using Code N in box 20 of Schedule K-1 for 2020. Carry forward any disallowed amount to the next taxable year. Partnerships with substantial gross receipts must provide partners with information necessary to apply the limitation at the partner level.
Step 7: Complete Schedule B and Required Supplements
Answer all 29 questions on Schedule B, Other Information. Report the entity type in question 1, indicating whether the partnership is a domestic general partnership, domestic limited partnership, domestic limited liability company, domestic limited liability partnership, foreign partnership, or other entity type.
Answer ownership questions 2a and 2b regarding whether any individual, estate, corporation, partnership, trust, tax-exempt organization, or foreign government owns 50% or more of the partnership. If yes to either question, attach Schedule B-1.
Answer question 4 regarding exemption from Schedules L, M-1, and M-2. Answer question 14 about foreign partners and complete the required foreign partner reporting. Answer question 16 regarding Form 1099 filing requirements. Answer question 23 regarding section 163(j) elections for real property trade, business, or farming business. Answer question 25 regarding the centralized partnership audit regime election. If you are not electing out, please complete the Designation of Partnership Representative section.
Step 8: Determine Required Schedules Based on Size and Activity
Partnerships are not required to complete Schedules L, M-1, and M-2 if they answer yes to all four parts of Schedule B, question 4. The four requirements are: total receipts for the tax year were less than $250,000, total assets at the end of the tax year were less than $1 million, Schedules K-1 are filed with the return and furnished to partners on or before the due date, including extensions, and the partnership is not filing and is not required to file Schedule M-3.
If any requirement is not met, complete Schedules L, M-1, and M-2. If adjusted total assets exceed $10 million or total receipts exceed $35 million, or if other Schedule M-3 filing requirements are met, attach Schedule M-3 instead of Schedule M-1. Complete Form 1125-A if the cost of goods sold is claimed. Attach Form 4562 if depreciation is claimed. Attach Form 8824 if a like-kind exchange occurred.
Step 9: Prepare and Distribute Schedule K-1 Using Tax Basis Method
Prepare one Schedule K-1 for each person who held a partnership interest at any time during tax year 2020. Report each partner’s capital account on Item L using the tax basis method. For partners who did not use tax basis in 2019, compute the beginning 2020 capital account using one of the three IRS-approved transition methods and include a statement identifying the method used.
Allocate all partnership income, gains, losses, deductions, credits, and special items to partners according to the partnership agreement and substantial economic effect rules under section 704(b). Include all required information about beginning and ending ownership percentages, share of partnership liabilities, and capital account changes. Report CARES Act and FFCRA items separately if applicable.
Furnish Schedule K-1 to each partner on or before the due date of the partnership return, including extensions. Partners use Schedule K-1 to report their share of partnership items on their individual or business tax returns.
Step 10: Sign, Verify Completeness, and File by Due Date
Any general partner or LLC member-manager must sign Form 1065 under penalties of perjury and enter the signature date. If a receiver, trustee, or assignee prepares the return on behalf of the partnership, the fiduciary must sign instead of a general partner.
Verify all required schedules, Schedules K-1, and supporting forms are attached. Confirm the filing deadline: March 15, 2021, for calendar year 2020 partnerships. The filing deadline is the 15th day of the 3rd month following the end of the partnership’s tax year. If filing an amended return, check the Amended Return box and attach a statement explaining all changes.
File Form 7004 to request a 5-month automatic extension if additional time is needed. The extended deadline for calendar year 2020 partnerships is September 15, 2021. Retain all partnership books, records, and copies of Schedules K-1 for IRS inspection under the centralized partnership audit regime regulations.
Important Form-Specific Rules and Limitations
Partner-Level Loss Limitations
Partners cannot claim partnership losses beyond their adjusted basis in the partnership interest under the basis limitation rules, amounts at risk in the activity under the at-risk limitation rules, or amounts allowed under passive activity limitation rules. The partnership reports beginning and ending capital accounts on Schedule K-1, Item L, but each partner is responsible for separately tracking their adjusted basis under section 705.
Disallowed losses carry forward indefinitely and may be claimed in future years when the partner has sufficient basis, at-risk amounts, or passive activity income to absorb the losses.
Oil and Gas Depletion
Partnerships cannot deduct oil and gas depletion on Form 1065, line 17. Each partner must calculate their share of oil and gas depletion separately on their individual return based on their proportionate share of the partnership’s adjusted basis in oil and gas properties.
Foreign Partnership Filing Exceptions
Foreign partnerships with effectively connected income, or with U.S. source income exceeding $20,000, or where 1% or more of partnership items are allocable to direct U.S. partners, must file Form 1065 unless they are withholding foreign partnerships. If a foreign partnership files Form 1065, all partners receive Schedule K-1, which reports both foreign and U.S. items.
No U.S. resident or nonresident alien deduction, credit, or exemption may be claimed directly on Form 1065. All pass-through items flow to partner returns only, where partners apply their individual limitations and make their own elections.
By following this comprehensive checklist, partnerships can ensure full compliance with all Form 1065 requirements for tax year 2020, properly implement mandatory tax basis capital account reporting, correctly apply COVID-19 relief provisions, and avoid penalties for late or incomplete filing.
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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.
