Form 1065 and Schedule K-1 Question - Reporting Retained Partnership Income

I'm part of a 4-person LLC where we each have equal 25% ownership. We're set up as a pass-through partnership for tax purposes. I know partners get taxed on the LLC's income rather than the LLC itself being taxed. Our situation is that the LLC made about $3,165.40 in income last year, but we decided to keep all of that money in our business account rather than distributing it to any partners. When filling out Form 1065, I entered $3,165.40 on line 11 of the Analysis of Net Income section on page 5. My question is about line 2: Do I need to enter $3,165.40 in field a(iv) for General Partners/Partnership, or can I just put 0 since none of us actually received any distributions? I'm confused because we kept all profits in the business account.

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18 comments

Hunter Brighton

•8M

That's a common point of confusion with partnership taxation. Even though you and your partners didn't physically take distributions, each partner is still considered to have received their share of the partnership income for tax purposes. This is called "phantom income" - you're taxed on it even though you didn't receive cash. On Form 1065 line 2, you should put $3,165.40 in field a(iv) for General Partners. The fact that you left the money in the business doesn't change each partner's tax obligation on their proportional share of income. Each partner will need to report their 25% share ($791.35) on their individual tax returns based on the Schedule K-1 you'll issue to them. Think of it this way - the decision to retain earnings in the business is made after the partnership has already earned the income. The tax code treats each partner as having received their share and then chosen to reinvest it back into the business.

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Hunter Brighton

•8M

You're exactly right - for tax purposes, it's treated as if each partner received their share and then reinvested it. That's why it's called "phantom income" - taxable without actual cash in hand. For line 19 (distributions), you would report zero if no actual distributions were made. This line is for tracking physical money that left the partnership and went to partners. So if all profits stayed in the business account, line 19 would show zero distributions, while the income is still allocated to partners on Schedule K-1.

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Dylan Baskin

•8M

Just wanted to share my experience with this exact situation. I kept running into confusion with my partnership returns until I found https://taxr.ai which helps analyze partnership tax documents. It flags these exact issues about phantom income vs distributions. Their system picked up that I was incorrectly reporting retained earnings on my Form 1065 and explained how phantom income works. Saved me from a potential audit situation because I was making the mistake of putting zeros where I should have been allocating income to partners. The service analyzes your specific tax situation and explains what goes where.

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Dylan Baskin

•8M

The document analysis works by scanning your tax forms to identify potential issues or inconsistencies. You only need to upload the specific pages you have questions about - in your case, just the Form 1065 pages with the income allocation sections. They use bank-level encryption and delete your docs after analysis. For complex partnership structures, it actually does handle special allocations and tiered partnerships. I had a situation with different profit/loss percentages versus ownership percentages, and it correctly identified how to report that. It's definitely more affordable than multiple calls to an accountant for specific questions.

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Lauren Wood

•8M

I tried taxr.ai after seeing it mentioned here, and it was super helpful! I had the exact same issue with my 3-member LLC where we retained all profits. I uploaded just my draft 1065 form, and it immediately flagged that I had income on line 11 but had entered zero for partner allocations. The analysis explained how phantom income works and showed me exactly where to record amounts on both Form 1065 and the K-1s. It even explained the difference between income allocation and distributions in plain English. My partners were initially confused about why they were getting K-1s showing income when "we didn't take any money out," but now they understand the pass-through concept.

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Chad Winthrope

•8M

If you're struggling to get more help with your partnership return, I'd suggest trying to contact the IRS directly, but good luck with that! After waiting on hold for hours, I discovered https://claimyr.com which got me connected to an actual IRS agent in about 20 minutes. You can see how it works at https://youtu.be/_kiP6q8DX5c I had similar confusion about reporting retained earnings on my partnership return and needed clarification directly from the IRS. Claimyr's service called the IRS, waited through the hold time, and then connected me once an agent was available. The IRS agent confirmed that partnership income flows through to partners regardless of distributions and explained exactly how to complete those lines.

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Chad Winthrope

•8M

The service works by using technology to navigate the IRS phone system and wait on hold for you. When you sign up, they call the IRS and use automated systems to stay on hold. Once they reach a real person, you get a call connecting you directly to the agent. You don't have to be on the phone during the hold time. It absolutely works - it's not magic, just clever use of technology to deal with the hold times. They're using the same phone system everyone else uses, but their system stays on hold so you don't have to. The IRS doesn't give them special access; they're just solving the hold time problem that makes most people give up.

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Kylo Ren

•8M

I was completely skeptical about Claimyr but decided to try it after struggling for weeks to get IRS clarification on my partnership return. I couldn't believe it when I got a call back connecting me to an actual IRS representative after about 25 minutes! The agent walked me through exactly how to handle retained earnings on Form 1065 and confirmed what others have said here - partnership income must be allocated to partners on line 2 and on K-1s regardless of whether distributions were made. They explained the difference between allocating income (required) and tracking distributions (separate line item). Saved me hours of frustration and potentially incorrect filing. Completely worth it just for the time saved.

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Nina Fitzgerald

•8M

Just want to add that this is one reason why many small LLCs elect S-Corp status once they're profitable. With an S-Corp, you can take part of your money as salary (which is subject to self-employment tax) and leave the rest in the business as retained earnings (which avoids SE tax). With a partnership, all allocated income (even if retained in the business) is potentially subject to self-employment tax for general partners. Something to consider if your LLC continues to grow.

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Nina Fitzgerald

•8M

Converting from a partnership to an S-Corp isn't particularly difficult. You file Form 8832 to elect to be taxed as a corporation, then file Form 2553 to elect S-Corp status. It can be done any time, but if you want it effective for the current tax year, there are deadlines to be aware of. For salary requirements, the IRS expects S-Corp owners to take a "reasonable salary" based on market rates for the work you do. There's no specific minimum, but it needs to be defensible if questioned. Too low a salary raises red flags because it looks like you're trying to avoid payroll taxes. For a small business, even a modest salary that's in line with what you'd pay someone else for the same work should satisfy the requirement.

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