You started a business with a partner. Things are going well, or maybe they’re just okay, but then March rolls around and you realize you have no idea how the IRS actually looks at your bank account. It’s a mess. Most people think an LLC is a thing that pays taxes. It isn’t. Not really.
The IRS basically treats your multi-member LLC like a "pass-through" entity. This means the company itself doesn't cut a check to Uncle Sam for income tax. Instead, the profits—and the painful losses—flow straight through to you and your partners. You pay the bill on your personal 1040. If you’re wondering how to do taxes for llc partnership setups, the first thing you need to accept is that you’re about to become very good friends with Form 1065.
It’s a bit of a paperwork nightmare.
The Form 1065 Beast and Why It Matters
The IRS wants to know what happened inside your business even if they aren't taxing the business directly. That is where Form 1065 comes in. Think of it as an "information return." You’re telling the government: "Hey, we made $200,000 this year, we spent $50,000 on software and coffee, and here is how we are splitting the leftovers."
Even if the business didn't make a dime, you usually still have to file this.
The deadline is the big kicker. Most people think tax day is April 15. For partnerships, it’s actually March 15. If you miss that, the penalties are aggressive. We are talking roughly $220 per month, per partner. If you have four partners and you’re three months late, you’re looking at over $2,600 in fines before you’ve even paid a cent in actual taxes.
What goes on the 1065?
You’ll need your gross receipts. You'll need your cost of goods sold (COGS) if you sell physical stuff. You’ll need every single deduction you can find—rent, repairs, legal fees, and that one printer you bought that immediately jammed. Honestly, the more detailed your bookkeeping is in QuickBooks or Xero, the less you’ll want to cry during this process.
The Magic of the Schedule K-1
Once the 1065 is finished, the business generates a Schedule K-1 for every single partner. This is the document that tells the IRS exactly what your "share" of the pie was.
If you own 50% of the business, your K-1 should reflect 50% of the profits. But here is where it gets weird: you pay taxes on your share of the profits regardless of whether you actually took the money out of the business bank account.
Imagine this. The LLC makes $100,000 in profit. You and your partner decide to keep all that cash in the business to buy a new delivery van next year. You didn't pay yourself a salary. You didn't take a "draw." Guess what? You still owe taxes on your $50,000 share of that profit. This is "phantom income," and it catches new entrepreneurs off guard every single year. You’ve got a tax bill but no extra cash in your personal pocket to pay it.
Distributive Shares vs. Guaranteed Payments
Most partnerships split things based on ownership percentage. That’s your distributive share. However, sometimes one partner does way more work than the other. In those cases, you might use "guaranteed payments."
- Guaranteed Payments: These are sort of like a salary for a partner. The LLC deducts them as an expense, and the partner receives the money regardless of whether the LLC made a profit.
- Distributive Shares: This is just the leftover profit divided up.
You’ve got to be careful here. Guaranteed payments are subject to self-employment tax.
Self-Employment Tax is the Real Budget Killer
When you work a W-2 job, your boss pays half of your Social Security and Medicare taxes. When you're in an LLC partnership, you are the boss. You pay both halves.
This is the 15.3% self-employment tax.
Many people calculate their income tax—say 22%—and think they’re fine. Then they realize they owe another 15.3% on top of that. It hurts. It really does. This applies to your distributive share of the ordinary income from the partnership if you are an active member. If you’re just a "silent partner" who invested money but doesn't do any work, you might be exempt from the self-employment portion, but you’ll still owe regular income tax.
State Taxes and the "Nexus" Problem
Don't forget the states. They want their cut too.
If your LLC is registered in Delaware but you’re doing business in California, California is going to want a piece of that action. This is called "nexus." Most states require partnerships to file a state-level version of the 1065. Some states, like California, even charge an annual "franchise tax" or a fee just for the privilege of existing as an LLC. In CA, that’s a minimum of $800 a year even if you lose money.
Common Mistakes That Trigger Audits
The IRS doesn't audit everyone, but they love looking at partnerships that have massive "miscellaneous" expenses.
Don't do that.
If you’re claiming $20,000 in "office supplies" but you’re a two-person consulting firm, they’re going to have questions. Another big red flag is the home office deduction. It’s totally legal, but you have to follow the rules. The space must be used exclusively for business. Your kitchen table doesn't count if you also eat dinner there.
Also, watch out for "commingling" funds. If you’re using the business credit card to buy groceries or pay for your Netflix subscription, you’re asking for trouble. Not only does it make how to do taxes for llc partnership filings a nightmare for your CPA, but it can also "pierce the corporate veil," meaning you could lose the liability protection the LLC was supposed to give you in the first place.
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Actionable Steps for Tax Season
First, get your books in order by January 31. You cannot wait until March to start sorting through shoeboxes of receipts.
Second, check your Partnership Agreement. Does it clearly state how profits and losses are shared? If you started the business on a handshake, get a written agreement now. The IRS defaults to an equal split if you don't have a document saying otherwise, which might not be what you actually intended.
Third, set aside 30% to 40% of your distributions in a high-yield savings account. It sounds like a lot because it is a lot. But when you factor in federal income tax, self-employment tax, and state tax, that 30% disappears fast.
Fourth, talk to a pro about the QBI deduction. The Qualified Business Income deduction (Section 199A) allows many LLC partners to deduct up to 20% of their pass-through income right off the top before taxes are calculated. It’s a huge break, but the rules are dense and depend on your total taxable income and the type of business you run.
Finally, file for an extension if you need to. Form 7004 gives you an extra six months to file the paperwork. Just remember: an extension to file is not an extension to pay. If you think you’ll owe money, you still need to send a check by the original deadline to avoid interest.
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Sorting out the taxes for a partnership is significantly harder than a solo gig, but it's manageable if you stop treating your business bank account like a personal piggy bank. Get the 1065 done early, hand out the K-1s, and keep a reserve for the IRS.
Next Steps to Stay Compliant:
- Download Form 1065 and Schedule K-1 from the IRS website to familiarize yourself with the data fields required.
- Reconcile your business bank accounts for the previous year to ensure every transaction is categorized.
- Verify the Social Security numbers or EINs of all partners to ensure the K-1s are issued correctly.
- Consult with a CPA specifically regarding the "Basis" in your partnership, as this determines if you can deduct losses on your personal return.