Partnership Tax Guide: Form 1065, Schedule K-1, Basis, and State Rules

Partnerships don’t pay federal income tax themselves. They file Form 1065, generate Schedule K-1s, and pass everything through to the partners — who then owe tax on income they may never have received in cash. This guide covers how that system works, what it means for your partnership agreement and your basis, and how state rules in California, New York, and New York City add extra layers. We wrote it for business owners who want to understand the mechanics, not just the headlines.

What You’ll Find in This Partnership Tax Guide

Partnerships file Form 1065 as an information return — no entity-level federal income tax, but late filing triggers penalties of $235 per partner per month (2026 rate).

Each partner gets a Schedule K-1 showing their share of income, deductions, credits and losses. The K-1 drives what you report on your personal Form 1040.

You can owe tax on income you never received. Allocations and distributions are separate concepts. A partner’s distributive share is taxable regardless of whether cash was distributed.

Basis is the gatekeeper. Outside basis determines whether losses are deductible and whether distributions are taxable. Get it wrong and the IRS will fix it for you — with penalties.

State rules vary wildly. California charges an $800 annual LLC fee plus a gross receipts fee. New York has a pass-through entity tax (PTET) election. New York City imposes the Unincorporated Business Tax (UBT) on partnerships doing business in the five boroughs.

New York State Partnership Tax Rules

New York requires partnerships to file Form IT-204, Partnership Return. The state follows federal income determinations with certain modifications — New York doesn’t conform to bonus depreciation under IRC Section 168(k), for example, so partnerships need to track New York-specific depreciation adjustments that flow through to their partners on Form IT-204-IP.

New York’s PTET, enacted in 2021 and since expanded, allows eligible partnerships and S corporations to elect to pay tax at the entity level at graduated rates ranging from 6.85% to 10.90% on the entity’s taxable income. Electing partnerships must make the election annually and pay estimated taxes quarterly. Partners receive a credit on their New York personal return equal to their pro-rata share of the entity-level tax paid. The election is irrevocable for the tax year once made.

For partnerships with partners in multiple states, the allocation and apportionment rules become complex. New York uses a three-factor formula (property, payroll, receipts) with double-weighted receipts for most businesses. Nonresident partners owe New York tax only on New York-source income, but the partnership is required to file a group return or provide information for each nonresident partner.

Detailed coverage at New York Partnership Tax Guide.

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Sources & References

IRS Publication 541 — Partnerships IRS About Form 1065 IRS Form 1065 Instructions IRS Schedule K-1 (Form 1065) Instructions IRS Form 8832 — Entity Classification Election California FTB — Partnerships NYC Unincorporated Business Tax 26 USC §701Partners, Not Partnership, Subject to Tax 26 USC §704Partner’s Distributive Share 26 USC §721Nonrecognition of Gain or Loss on Contribution 26 USC §731Extent of Recognition of Gain or Loss on Distribution 26 USC §752Treatment of Certain Liabilities 26 USC §761Terms Defined IRS Partnership Tax Center CA FTB Form 540California Resident Income Tax Return CA FTB 540 BookletInstructions