Maximizing tax efficiency: learn how to handle partner and shareholder income

Reporting information from a partner's Schedule K-1 (Form 1065) or a shareholder's Schedule K-1 (Form 1120-S) can be a challenging task for preparers. In a three-part webinar series, we will debunk the process of reporting pass-through items on the owner's return.

Below, you’ll find a few of the top questions from a recent webinar on the topic and their accompanying answers. If you choose to attend the on-demand version of this webinar, you can access the full recording and the entire list of Q&As.   

Q: What is an example of use of capital? Can you define that and how it differs from a payment for services?

A: A guaranteed payment for the use of capital isn’t a payment for services provided to the partnership. It’s a payment for the partnership’s use of a partner’s contributed capital.

Q: If other net rental income is always passive, why is it subject to self-employment (SE) tax?

A: Other net rental income is passive because it involves rental activity. If the partnership regularly and continuously rents out tangible personal property to make a profit, general partners are subject to SE tax on other net rental income. However, limited partners are not subject to SE tax on this income.

Q: Are you using the term “partner” to denote people actively involved in the business and “shareholders” to denote passive members (LLC) who are not subject to SE tax?

A: No. She’s referring to partnerships and S corporations, so she means a partner in a partnership or a shareholder in an S corporation. S corporation shareholders are not subject to SE tax on their pass-through income. However, general partners are subject to SE tax on their pass-through income and guaranteed payments.

Q: What criteria must be considered to qualify for the $25,000 special allowance for real estate rental activities if the partner or S corporation shareholder is not a real estate professional?

A: The partner or shareholder must own at least 10% of the partnership or S corporation, and they must have participated in making management decisions or arranging for others to provide services (such as repairs) in a significant and bona fide sense. Except as provided in regulations, limited partners aren’t treated as actively participating in a partnership’s rental real estate activities.