This filled-in Form 1065 is for the AbleBaker Book Store, a partnership composed of Frank Able and Susan Baker. The partnership uses an accrual method of accounting and a calendar year for reporting income and loss. Frank works full time in the business, while Susan works approximately 25% of her time in it. Both partners are general partners.

The partnership agreement states that Frank will receive a yearly guaranteed payment of $20,000 and Susan will receive $5,000. Any profit or loss will be shared equally by the partners. The partners are personally liable for all partnership liabilities. Both partners materially participate in the operation of the business.

In addition to receiving income and paying expenses in its partnership operations, AbleBaker made a $650 cash charitable contribution, received $150 from dividends, and received $50 tax-exempt interest from municipal bonds.

Frank completes the partnership's Form 1065 as explained next.

Page 1

The IRS sent Frank a postcard with his preaddressed label, asking if he needed a Form 1065 package. He returned the postcard and the IRS sent him the package. When Frank completes the return, he places the label in the address area on page 1.

Frank supplies all the information requested at the top of the page.

Income

The partnership's ordinary income from the trade or business activity is shown on lines 1a through 8.

Line 1. Gross sales of $409,465 are entered on line 1a. Returns and allowances of $3,365 are entered on line 1b, resulting in net sales of $406,100, entered on line 1c.

Line 2. Cost of goods sold, $267,641, from Schedule A, line 8, is entered here.

Line 3. Gross profit of $138,459 is shown on this line.

Line 7. Interest income on accounts receivable, $559, is entered on this line. The schedule that must be attached for this line is not shown.

Line 8. Total income, $139,018 (lines 3 through 7), is shown here.

Deductions

The partnership's allowable deductions are shown on lines 9 through 21.

Line 9. All salaries and wages are included here except guaranteed payments to partners (shown on line 10). Frank enters the $29,350 wages paid to the partnership's employees. The partnership had no employment credits to reduce that amount.

Line 10. Guaranteed payments of $25,000 to partners Frank ($20,000) and Susan ($5,000) are entered here.

Line 11. Repairs of $1,125 made to partnership equipment are entered on this line.

Line 12. During the year, $250 owed to the partnership was determined to be a wholly worthless business bad debt. The $250 is shown on this line. (If this had been a nonbusiness bad debt, it would have been reported in Part I of Schedule D (Form 1065) and included separately on Schedules K and K-1, line 7, as a stated short-term capital loss.)

Line 13. Rent paid for the business premises, $20,000, is listed on this line.

Line 14. Deductible taxes of $3,295 are entered on this line.

Line 15. Interest paid to suppliers during the year totaled $1,451. This is business interest, so it is entered here.

Lines 16a and 16c. Depreciation of $1,174 claimed on assets used in the partnership's business is entered on these lines. (Line 16b is left blank because there is no depreciation listed elsewhere on the return.) Frank does not need to attach Form 4562 because the partnership did not place property in service during 2000 or depreciate a car or other listed property.

Line 20. Other allowable deductions of $8,003 not listed elsewhere on the return and for which a separate line is not provided on page 1 are included on this line. Frank attaches a schedule that lists each deduction and the amount included on line 20. This schedule is not shown.

Line 21. The total of all deductions, $89,648 (lines 9 through 20), is entered on this line.

Line 22. The amount on line 21 is subtracted from the amount on line 8. The result, $49,370, is entered here and on line 1 of Schedule K. The amount allocated to each partner is listed on line 1 of Schedule K-1.

Signatures

Frank signs the return as a general partner. The AbleBaker Book Store did not have a paid preparer.

Page 2 Schedule A

Schedule A shows the computation of cost of goods sold. Beginning inventory, $18,125, is entered on line 1 and net purchases, $268,741, are entered on line 2. The total, $286,866, is entered on line 6. Ending inventory, $19,225 (entered on line 7), is subtracted from line 6 to arrive at cost of goods sold, $267,641 (entered on line 8 and on page 1, line 2).

Frank answers all applicable questions for item 9.

Schedule B

Schedule B contains 11 questions about the partnership. Frank answers question 1 by marking the "Domestic general partnership" box. He answers questions 2 through 11 by marking the "No" boxes.

Question 5 asks if the partnership meets all the requirements listed in items 5a, b, and c. Because the partnership's total receipts were not less than $250,000, all three of these requirements are not met. Frank must complete Schedules L, M-1, M-2, and item F on page 1 of Form 1065 and item J on Schedule K-1.

Pages 3 - 4 Schedule K

On Schedule K, Frank lists the total of both partners' shares of income, deductions, credits, etc. Each partner's distributive share of income, deductions, credits, etc., is reported on Schedule K-1. The line items for Schedule K are discussed in combination with the Schedule K-1 line items, later.

Page 4--Analysis of Net Income (Loss)

An analysis must be made of the distributive items on Schedule K. This analysis is based on the type of partner. Since the AbleBaker Book Store has two individual partners, both of whom are "active" general partners, the total on line 1, $73,870, is entered on line 2a, column ii.

Page 4 Schedules L, M-1, and M-2

Partnerships do not have to complete Schedules L, M-1, or M-2 if all of the tests listed under question 5 of Schedule B are met and question 5 is marked "Yes." The AbleBaker Book Store does not meet all of the tests, so these schedules must be completed.

Schedule L

Schedule L contains the partnership's balance sheets at the beginning and end of the tax year. All information shown on the balance sheets for the AbleBaker Book Store should agree with its books of record.

The entry in column (d) of line 14 for total assets at the end of the year, $45,391, is carried to item F at the top of page 1 since the answer to question 5 on Schedule B was "No."

Schedule M-1

Schedule M-1 is the reconciliation of income per the partnership books with income per Form 1065.

Line 1. This line shows the net income per books of $48,920. This amount is from the profit and loss account (not shown in this example).

Line 3. This line shows the guaranteed payments to partners.

Line 5. This is the total of lines 1 through 4 of $73,920.

Line 6. Shown here is the $50 tax-exempt interest income from municipal bonds recorded on the books but not included on Schedule K, lines 1 through 7. This interest is reported on Schedule K, line 19.

Line 9. This is line 5 less line 8, $73,870. This line is the same as line 1 of the Analysis of Net Income (Loss) section of Schedule K at the top of page 4.

Schedule M-2

Schedule M-2 is an analysis of the partners' capital accounts. It shows the total equity of all partners at the beginning and end of the tax year and the adjustments that caused any increase or decrease. The total of all the partners' capital accounts is the difference between the partnership's assets and liabilities shown on Schedule L. A partner's capital account does not necessarily represent the tax basis for an interest in the partnership.

Line 1. As of January 1, the total of the partners' capital accounts was $27,550 (Frank -- $14,050; Susan -- $13,500). This amount should agree with the beginning balance shown on line 21 of Schedule L for the partners' capital accounts.

Line 3. This is the net income per books.

Line 5. This is the total of lines 1 through 4.

Line 6. Each partner withdrew $26,440 (totaling $52,880) from the partnership. These withdrawals are shown here and on Schedule K, line 22. The partners' guaranteed payments, which were actually paid, are not included because they were deducted when figuring the amount shown on line 3.

Line 9. This shows the total equity of all partners as shown in the books of record as of December 31. This amount should agree with the year-end balance shown on line 21 of Schedule L for the partners' capital accounts.

Item J on Schedule K-1 reflects each partner's share of the amounts shown on lines 1 through 9 of Schedule M-2.

Schedule K-1

Schedule K-1 lists each partner's share of income, deductions, credits, etc. It also shows where to report the items on the partner's individual income tax return. Illustrated is a copy of the Schedule K-1 for Frank W. Able. All information asked for at the top of Schedule K-1 must be supplied for each partner.

Allocation of Partnership Items

The partners' shares of income, deductions, etc., are shown next.

Income (Loss)

Line 1. This line on Schedule K-1 shows Frank's share ($24,685) of the income from the partnership shown on Form 1065, page 1, line 22. The total amount of income to both partners is shown on line 1, Schedule K.

Line 4b. Dividends must be separately stated. They are not included in the income (loss) of the partnership on Form 1065, page 1, line 22. This line on Schedule K-1 shows Frank's share, $75. This line on Schedule K shows the total dividends of $150.

Line 5. This line on Schedule K-1 shows only the guaranteed payments to Frank of $20,000. This line on Schedule K shows the total guaranteed payments to both partners of $25,000.

Deductions

Line 8. During the year, the partnership made a $650 cash contribution to the American Lung Association. Each partner may be able to deduct his or her share of the partnership's charitable contribution on his or her individual income tax return if the partner itemizes deductions. Frank's share of the contribution, $325, is entered on this line of Schedule K-1. This line on Schedule K shows the total contribution.

Investment Interest

Line 14b. The partnership had no interest expense on investment debts, but it had investment income (dividends) of $150 as shown on line 4b, Schedule K. That amount is also shown on this line of Schedule K, and the partner's share is shown on this line of Schedule K-1.

Self-Employment

Line 15a. Net earnings (loss) from self-employment are figured using the worksheet in the Form 1065 instructions for Schedule K (not shown). Frank and Susan's net earnings from self-employment are the total of the partnership income shown on line 1 of Schedule K and the guaranteed payments shown on line 5. This total, $74,370, is entered on Schedule K, and each individual partner's share is shown on his or her Schedule K-1. Each partner uses his or her share to figure his or her self-employment tax on Schedule SE (Form 1040), Self-Employment Tax (not shown).

Other

Line 19. Frank enters the $50 municipal bond interest received by the partnership on this line of Schedule K and $25 on this line of each partner's Schedule K-1.

Line 22. Frank enters the $52,880 cash withdrawals made by the partners during the year on this line of Schedule K. He enters the amount each partner withdrew on this line of the partner's Schedule K-1.

Form 1065 page 1

Form 1065 page 2

Form 1065 page 3

Form 1065 page 4

Schedule K-1 page 1

Schedule K-1 page 2

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