Partnership Taxes and Form 1065

A partnership is a business owned by two or more people who share its profits and losses. A domestic LLC with two or more members is taxed as a partnership by default unless it elects otherwise. The partnership files an information return, Form 1065, but generally pays no federal income tax itself. The income passes through to the partners. This guide explains partnership taxes, Form 1065 and Schedule K-1, partner payments, penalties and Illinois rules.

How partnership taxation works

Each partner pays tax on a distributive share of the partnership's income, whether or not cash is distributed. The partnership agreement controls how income, deductions and losses are allocated, as long as the allocations meet tax rules.

Putting property into a partnership generally causes no gain or loss for the partner or the partnership. A partner's basis in the interest starts with cash plus the adjusted basis of property contributed, rises with income and the partner's share of partnership debt, and falls with distributions. A distribution is taxed only when cash received exceeds the partner's basis.

Example: Two partners each own 50% of an LLC. For 2025, the LLC earns $130,000 before paying Partner A a $30,000 guaranteed payment for management work. After that payment, $100,000 remains, split $50,000 each. Partner A reports $80,000 ($30,000 plus $50,000) and Partner B reports $50,000, regardless of how much cash was distributed.

Guaranteed payments and benefits

Guaranteed payments are amounts a partnership pays a partner without regard to partnership income, such as a salary-like payment for services or interest on capital. The partnership deducts them, and the partner reports them as ordinary income. Health insurance premiums the partnership pays for a partner are treated as guaranteed payments, and the partner may be able to deduct them. See health insurance for the self-employed.

Because partners are not employees, a partnership does not run payroll for them. Partners usually pay quarterly estimated taxes.

Self-employment tax

General partners generally owe self-employment tax on their share of ordinary business income and on guaranteed payments for services. A limited partner's share of income is generally not self-employment income, but guaranteed payments for services actually performed are. Whether an LLC member counts as a limited partner for this purpose depends on section 1402(a)(13) of the tax code and the facts, so members who work in the business should get advice rather than assume an exception.

Forms, deadlines and penalties

• Form 1065 is due the 15th day of the 3rd month after year-end. Form 7004 extends the time to file by six months but not the time to pay.
• Schedule K-1 goes to every partner. Schedules K-2 and K-3 apply to international items, with several filing exceptions.
• E-filing is required for partnerships with more than 100 partners and for filers of 10 or more returns of any type.
• Late filing costs $255 per partner per month or part of a month, up to 12 months, for returns due in 2026 (tax year 2025). Missing or incorrect K-1s cost $340 per schedule for tax year 2025.

Reasonable cause can excuse the penalty. Small partnerships with 10 or fewer partners, all individuals or estates, with allocations in the same proportion and all income reported on time, may qualify for relief under Rev. Proc. 84-35. See the late-filing penalty for partnerships and S corporations.

Partnership audits and the partnership representative

Under the centralized audit regime, every partnership names a partnership representative each year on Form 1065. That person, who must have a substantial presence in the United States, has sole authority to act for the partnership in an IRS examination. An entity can serve if it appoints a designated individual.

A partnership with 100 or fewer eligible partners can elect out of this regime on Schedule B-2, but only on a timely filed return. Eligible partners are individuals, C corporations, S corporations, certain foreign entities and estates of deceased partners. A partnership with a partnership or trust as a partner cannot elect out. Your operating agreement should say who the representative is and how decisions are made.

Illinois notes

Illinois partnerships do not pay Illinois income tax. They pay personal property replacement tax of 1.5% of net income, and partners pay Illinois income tax on their shares at a flat 4.95% for individuals. Form IL-1065 is due the 15th day of the 4th month after year-end, a month later than the federal return, with an automatic six-month extension to file. Tax is still due on the original date.

Illinois also offers an elective pass-through entity (PTE) tax of 4.95% of net income, with a credit to partners. For tax years ending on or after December 31, 2026, partnerships that elect may choose between two methods of setting the tax base, and they declare the choice on Form IL-1065. Partnerships also make pass-through withholding payments for nonresident partners.

Common mistakes

• Paying partners "wages" through payroll instead of guaranteed payments or distributions
• Skipping an operating agreement, or leaving allocations and the representative undefined
• Not tracking each partner's basis
• Ignoring partner-level estimated tax
• Forgetting the separate Illinois return and its different due date

How we can help

We can prepare Form 1065, Schedule K-1s and the Illinois return, review how your agreement allocates income, and compare staying a partnership with an S election. See business tax preparation, tax planning and LLC tax classification.

Frequently asked questions

General information only, not tax, legal or accounting advice for your situation. Rules, limits and deadlines change; confirm the current rules with the official source or a qualified professional before you act. Reading this page does not create a professional relationship with CPA Tax Payroll and Accounting Corp.