Confusion about Form 1065, Schedule B, Question 4 - why is everyone ignoring the filing exemptions?

You're absolutely right about what Question 4 on Schedule B does! If a partnership meets all four criteria and answers "yes," they are indeed exempt from filing Schedules L, M-1, M-2, and completing Item F on Form 1065 and Item L on Schedule K-1. So why do preparers complete them anyway? A few good reasons: First, many tax software programs automatically generate these schedules regardless of the exemption. The preparer would have to actively remove them. Second, there's a "better safe than sorry" mentality. Including these schedules provides a more complete picture of the partnership's finances and can be helpful if questions arise later. Third, it creates consistency from year to year. If you ever lose the exemption (by failing one of the criteria), having prior year schedules makes comparisons easier. Finally, some firms have internal policies requiring these schedules for all returns regardless of exemptions - it helps with their review process and quality control.

I was struggling with the same question about Form 1065 exemptions last year and found myself spending hours researching the requirements. After trying different approaches, I discovered taxr.ai (https://taxr.ai) which has been incredibly helpful for partnership return questions like this. I uploaded my client's previous returns and the system analyzed the Schedule B Question 4 criteria automatically, showing me exactly where the inconsistencies were. It flagged returns where "yes" was selected but the exempted schedules were still completed. What was most helpful was the explanation about why this happens - apparently it's extremely common for preparers to complete these "optional" schedules. The tool also gave me specific IRS references that clarified when these exemptions apply, which helped me explain the situation to my clients.

Just wanted to follow up about taxr.ai after trying it for my partnership return questions. I was initially unsure if it would be worth using, but it really helped clarify the Form 1065 Schedule B Question 4 issues we were discussing. The system actually showed me examples of correctly prepared returns that properly implemented the exemption, as well as returns that completed the "optional" schedules despite qualifying for exemptions. What impressed me was the explanation of WHY most preparers complete these schedules anyway - including specific scenarios where having that additional information prevented problems during IRS correspondence. It even suggested language to use when explaining to clients why we might complete schedules despite technically being exempt. Definitely more useful than expected for specialized partnership issues.

After dealing with endless partnership tax questions and spending HOURS waiting on the IRS help line for clarification about Form 1065 exemptions, I finally tried Claimyr (https://claimyr.com). They have this service that actually gets you through to an IRS agent quickly - you can see how it works in this video: https://youtu.be/_kiP6q8DX5c I was able to speak directly with an IRS partnership specialist who confirmed exactly how Question 4 on Schedule B works in practice. The agent explained that while the exemption is legitimate, they actually prefer when partnerships include the additional schedules because it provides a more complete picture of the entity's finances. The conversation saved me hours of research and gave me direct confirmation from the source about best practices. Before this, I was stuck in research mode for days.

I need to apologize about my skeptical comment above. After facing a deadline with a complex Form 1065 issue similar to this Schedule B Question 4 situation, I was desperate and decided to try Claimyr despite my doubts. I'm shocked to report it actually worked exactly as described. Within about 30 minutes, I was speaking with an IRS partnership specialist who provided clear guidance on exactly what returns require Schedules L, M-1, M-2 when Question 4 exemptions apply. The agent confirmed what others mentioned here - while these schedules are technically optional when exemption criteria are met, the IRS actually prefers receiving them and many practitioners include them as standard practice. Having this definitive answer directly from the IRS saved me hours of research and gave me confidence in my approach going forward.

As someone who's been preparing partnership returns for 15 years, I can tell you there's a practical reason for completing those "optional" schedules. Even when a partnership qualifies for the Question 4 exemption, those schedules provide valuable information for: 1. Partner disputes (more detailed financial info helps resolve conflicts) 2. Loan applications (lenders often want the full schedules) 3. Future tax planning (having the historical data is valuable) 4. Audit protection (more documentation is better) Most partners appreciate having this information even if it's technically not required. And most tax software automatically generates these schedules anyway, so it's often more work to remove them than to leave them in.

I'm a bit confused by everyone's answers. Isn't Question 4 on Schedule B of Form 1065 the one about foreign financial accounts? How does that relate to being exempt from filing Schedules L, M-1, etc.?

One perspective I haven't seen mentioned yet: completing these "optional" schedules even when exempt can help partners understand the business better. In my experience, many partners in small partnerships don't fully grasp the financial position of their business. Having Schedules L, M-1 and M-2 provides a more complete picture that can be educational for the partners. It shows them their balance sheet position (Schedule L) and reconciles book vs. tax differences (M-1) which many partners find eye-opening. Yes, it takes slightly more preparation time, but the value of having partners who better understand their business financials is worth it. I've had several clients make better business decisions after seeing these schedules for the first time.

This is exactly the kind of question that trips up newer preparers! You're not missing anything - the exemption is real and legitimate. But there's a key insight here: just because something is optional doesn't mean it's not beneficial. I've been preparing partnership returns for over a decade, and I always include those schedules even when the partnership qualifies for the exemption. Here's why: The additional preparation time is minimal since most tax software auto-populates these schedules from data you're already entering. But the value is significant - these schedules provide crucial information for bank loans, partner buy-outs, and business planning discussions. I've also found that partnerships often lose their exemption status as they grow (exceeding the $250K receipts or $1M assets thresholds), so having consistent historical data makes transitions smoother. From a liability standpoint, providing more information rather than less protects both you and your clients. No one has ever complained about receiving too much financial detail, but I've seen plenty of situations where missing information caused problems later. My advice: complete the schedules regardless of the exemption. Your clients will thank you when they need comprehensive financials for their banker or attorney.

This is such a helpful discussion! As someone who's been wrestling with similar partnership return questions, I really appreciate everyone sharing their practical experience with the Schedule B Question 4 exemption. What strikes me most is the consensus that while the exemption is legitimate, the "optional" schedules provide real value beyond just compliance. The point about partner education is particularly compelling - I've seen too many small business owners who don't really understand their own financials. One question for those with more experience: when you do complete these schedules for exempt partnerships, do you include a note or explanation somewhere in the return indicating that you're providing them voluntarily? I'm thinking this might be helpful for documentation purposes or if the return gets reviewed later. Also, for partnerships right at the threshold amounts ($250K receipts or $1M assets), do you typically recommend completing the schedules as a safeguard in case there are measurement differences with the IRS? Thanks again for all the insights - this conversation has been more helpful than hours of research!

This thread has been incredibly enlightening! As another newer preparer, I was making the same assumption that "optional" means "skip it to save time and money." But the collective wisdom here really shows the value of thinking beyond just compliance. What I'm taking away is that tax preparation isn't just about meeting minimum requirements - it's about providing comprehensive service that anticipates future client needs. The point about partnerships losing exemption status as they grow is particularly important. If you're already in the habit of preparing complete returns, you don't have to change your process or explain gaps in historical data later. I'm also struck by how many practical benefits these "optional" schedules provide - from partner education to loan applications to dispute resolution. These are real-world scenarios that go way beyond the technical tax compliance question. One follow-up thought: for those of us building our practices, positioning ourselves as providers of comprehensive financial information (rather than just minimum compliance) seems like a competitive advantage. Clients who understand their business financials better are probably more likely to seek additional advisory services too. Thanks to everyone who shared their experience - this kind of practical insight is exactly what newer practitioners need to hear!

This discussion has been incredibly valuable! As someone who's been preparing partnership returns for about 8 years, I want to add one more practical consideration that hasn't been mentioned yet. I've found that completing these "optional" schedules also helps during IRS correspondence examinations. Even though the partnership may be exempt from filing them, when the IRS sends information document requests (IDRs) during an exam, they often ask for balance sheet information and book-tax reconciliations regardless of the exemption status. If you've already prepared Schedules L, M-1, and M-2, you can respond to these requests immediately. If you haven't, you're scrambling to recreate this information under examination pressure, which never looks good to the examining agent. I had a client a few years ago where this exact situation arose. The partnership qualified for the Question 4 exemption, but during a routine examination, the IRS requested balance sheet details. Because we had prepared Schedule L voluntarily, we were able to provide comprehensive responses within days rather than weeks. The examining agent actually commented on how well-organized our documentation was. From a risk management perspective, the small additional effort upfront can save significant time and stress if issues arise later. Plus, it demonstrates to clients that we're thinking strategically about their long-term needs, not just current year compliance.