Partnerships are a popular form of business organization in the United States. A partnership is formed when two or more individuals come together to carry on a business for profit. While partnerships offer many advantages, they also come with certain tax filing requirements that partners must be aware of. Today we are discussing about tax return filing requirements by a Domestic Partnership, i.e., one which is formed in the US, and thus, is not a foreign partnership.
Partnership Tax Return Form
One of the most important tax filing requirements for partnerships is the filing of Form 1065, also known as the U.S. Return of Partnership Income. This form is used to report the partnership’s income, deductions, and other financial information to the Internal Revenue Service (IRS). Even if the partnership does not have any taxable income, it is still required to file Form 1065.
Partnerships must also provide each partner with a Schedule K-1, which reports the partner’s share of the partnership’s income, deductions, and credits. The partnership must file a separate Schedule K-1 for each partner. The due date for providing Schedule K-1 to partners is the same as the due date for filing Form 1065.
Partnerships that controlling stake in foreign partnerships/corporations/branch or disregarded entities may need to file any of these applicable forms. These forms are a part of international tax compliance as required by the IRS.
Please note that these forms are complex and require a thorough understanding of the relevant laws applicable. We recommend connecting with the experts in this domain and take advisory before filing with the IRS. The penalties for these forms vary from $10,000 to $50,000 depending upon the non-compliance occurred.
State and Local Taxes (SALT)
In addition to these requirements, partnerships may also be subject to state and local tax filing requirements.
This area can be very tricky and complicated, partnerships should consult with a tax professional to determine the specific tax filing requirements for their business.
Permissible accounting methods are:
- Accrual, or
- Any other method authorized by the Internal Revenue Code.
Generally, a partnership may use the cash method of accounting unless it’s required to maintain inventories, has a C corporation as a partner, or is a tax shelter (as defined in section 448(d)(3)). However, for tax years beginning after 2017, any partnership qualifying as a small business taxpayer can use the cash method.
Is filing Form 1065 is mandatory to IRS?
Yes, filing Form 1065, also known as the U.S. Return of Partnership Income, is mandatory for partnerships in the United States. All partnerships are required to file this form with the Internal Revenue Service (IRS) regardless of whether they have any taxable income or not. The purpose of this form is to report the partnership’s income, deductions, and other financial information to the IRS.
Additionally, the form helps the IRS to determine each partner’s share of the partnership’s income or loss, which the partners will report on their individual tax returns. Therefore, filing Form 1065 is an essential requirement for partnerships to comply with their tax obligations in the US.
What information is required to be filled in Form 1065?
Though full information cannot be detailed in an article, we are listing the most important areas of the information that is required to be filled in Form 1065 includes:
- Partnership Information: This section requires the partnership to provide its name, address, Employer Identification Number (EIN), and the date it started business.
- Income: This section requires the partnership to report all its income from all sources, including sales, services, rents, and gains or losses from the sale of property.
- Deductions: This section requires the partnership to report all its expenses, such as salaries and wages, rent, utilities, and supplies.
- Partner’s Share of Income, Deductions, Credits, etc.: This section requires the partnership to report each partner’s share of the partnership’s income, deductions, credits, and any other tax items.
- Other Information: This section requires the partnership to provide additional information about certain transactions, such as contributions to retirement plans and investments in foreign partnerships.
- Signatures: This section requires the partnership’s authorized representative to sign and date the tax return.
What is the due date for filing Form 1065?
The due date for filing Form 1065 is the 15th day of the third month following the end of the partnership’s tax year. For example, if the partnership’s tax year ends on December 31, the tax return is due on March 15 of the following year. If the due date falls on a weekend or holiday, the due date is moved to the next business day.
Extension of time to file!
Partnership can file Form 7004, Application for Automatic Extension of Time To File Certain Business Income Tax, Information, and Other Returns, to request an 6-months extension of time to file. Form 7004 must be filed by the original due date of the partnership return (in most cases March 15). Form 7004 can be electronically filed.
What is the consequence of failure of filing Form 1065?
Partnerships that fail to file Form 1065 and provide each partner with a Schedule K-1 can face penalties and interest charges.
The penalty for failure to file a partnership tax return in time is $220 for each month or part of a month (for a maximum of 12 months) the failure continues, multiplied by the total number of persons who were partners in the partnership during any part of the partnership’s tax year for which the return is due.
Failure To Furnish Information Timely
For each failure to furnish Schedule K-1 (and K-3, if applicable) to a partner when due and each failure to include on Schedule K-1 (and K-3, if applicable) all the information required to be shown (or reporting incorrect information), a $290 penalty is imposed for each Schedule K-1 (and K-3, if applicable) for which a failure occurs.
The maximum penalty is $3,532,500 for all such failures during a calendar year. If the requirement to report correct information is intentionally disregarded, each $290 penalty is increased to $580 or, if greater, 10% of the aggregate amount of items required to be reported. There is no limit to the amount of the penalty in the case of intentional disregard of the timely filing of the return.
- The partnership must usually keep records that support an item of income, deduction, or credit on the partnership return for 3 years from the date the return is due or is filed, whichever is later.
- These records must usually be kept for 3 years from the date each partner’s return is due or is filed, whichever is later.
- It must also keep records that verify the partnership’s basis in property for as long as they are needed to figure the basis of the original or replacement property.
- The partnership should also keep copies of all returns it has filed. They help in preparing future returns and in making computations when filing an amended return.
Indian Partners in a US Partnership
Indian partners of a US partnership are subject to certain tax implications under the US tax laws. The Internal Revenue Service (IRS) requires that the US partnership must withhold taxes on the Indian partner’s distributive share of effectively connected income (ECI) from US sources. The withholding rate is generally 37% but may be reduced under certain tax treaties.
US partnerships are required to withhold tax on the foreign partner’s distributive share of effectively connected income (ECI) from US sources, even if the partnership never makes any cash distributions to the Indian partner. The withholding tax is based on the Indian partner’s share of the partnership’s ECI, regardless of the foreign partner’s ultimate US tax liability.
The purpose of the withholding tax is to ensure that the IRS receives tax revenue from the foreign partner’s US source income, even if the foreign partner does not file a US tax return or pay US tax on the income. The foreign partner may be able to claim a credit for the withholding tax on their home country tax return or US non-resident tax return, depending on the tax laws of their home country and any applicable tax treaty provisions.
Here are some additional points to keep in mind:
- Form 8804 and 8805: The US partnership must file Form 8804 and 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax, to report the foreign partner’s share of the ECI and the amount of withholding tax.
- Taxation of ECI: ECI is generally income that is effectively connected with the conduct of a US trade or business. ECI includes, but is not limited to, income from services performed in the US, sales of inventory or property located in the US, and gains from the sale of US real property interests.
- Taxation of non-ECI: If the Indian partner’s share of income is not ECI, then the partnership is not required to withhold tax on the distribution. However, the Indian partner may still be subject to US taxation on this income, depending on the type of income and any applicable tax treaty provisions.
- Filing requirements: Indian partners of a partnership must generally file a US income tax return (Form 1040NR) and report their share of the partnership’s income, gains, losses, and deductions.
Tax implications in India on Indian Partners
- Income Disclosures
- The Indian partners of a US partnership must show the income from the US partnership in the same head as received by them in Shcedule K-1 (Form 1065). It simply means that if the US partnership earned Business income and Capital Gain income in a particular year, then Indian partners must show that portion of Business income in PGBP head and Capital Gains income in Capital Gains head in their India Tax return.
- Reporting Disclosures
- Schedule FA – Details of Foreign Financial Interests, is required to be completed as the” assessee” holds a financial interest in the entity which is a limited partnership.
- Schedule FSI – Details of Income accruing or arising outside India, is to be completed to disclose the US source income earned by the assessee
- FTC Issues (DTAA Benefit)
- If the Indian partners are tax resident in India for the Assessment Year in question, they will be eligible to claim double taxation relief in India on the income from the US partnership.
- If the Indian partners are subject to tax, in the US, on the share of income of the US partnership, then such amount shall be available as FTC in India subject to conditions of Section 90 of Income Tax Act, 1961.
- Set-off and Carry Forward of losses
- Set-off of losses is available as per the Intra head and Inter head adjustment provisions in India.
- Carry forward of losses is available subject to Section 71B, 72, 73, 73A, 74, 74A, 80 of the Income Tax Act, 1961
- Carry forward of losses under the head “Income from other sources” is not allowed.
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