U.S. Return of Partnership Income
Schedule A - Cost of Goods Sold
Cost of Goods Sold
Generally, inventories are required at the beginning and end of each tax year if the production, purchase, or sale of merchandise is an
income-producing factor. See Regulations section 1.471-1.
However, if the partnership is a qualifying taxpayer, it may adopt or change its accounting method to account for inventoriable items in the same
manner as materials and supplies that are not incidental. A qualifying taxpayer is a taxpayer (a) whose average annual gross
receipts for the 3 prior tax years are $1 million or less and (b) whose business is not a tax shelter (as defined in section 448(d)(3)).
In addition, for tax years ending on or after December 31, 2001, this rule applies to an eligible business of a qualifying small business taxpayer. A
qualifying small business taxpayer includes a partnership with average annual gross receipts of more than $1 million but less than or equal
to $10 million and that is not prohibited from using the cash method under section 448. For more details, including the definition of an eligible
business, see Notice 2001-76.
Under this accounting method, inventory costs for raw materials purchased for use in producing finished goods and merchandise purchased for resale
are deductible in the year the finished goods or merchandise are sold (but not before the year the partnership paid for the raw materials or
merchandise, if it is also using the cash method). Enter amounts paid for all raw materials and merchandise during the tax year on line 2. The amount
the partnership can deduct for the tax year is figured on line 8. For additional guidance on this method of accounting for inventory items, see Rev.
Proc. 2001-10, 2001-2 I.R.B. 272 and Pub. 538.
All filers not using the cash method of accounting should see Section 263A uniform capitalization rules on page 15 before completing
Schedule A. The instructions for lines 2 through 9 on page 19 apply to Schedule A.
Line 1 - Inventory at Beginning of Year
If the partnership is changing its method of accounting for the current tax year, it must refigure last year's closing inventory using its new
method of accounting and enter the result on line 1. If there is a difference between last year's closing inventory and the refigured amount, attach
an explanation and take it into account when figuring the partnership's section 481(a) adjustment (explained on page 5).
Line 2 - Purchases
Reduce purchases by items withdrawn for personal use. The cost of these items should be shown on line 23 of Schedules K and K-1 as distributions to
partners.
Line 4 - Additional Section 263A Costs
An entry is required on this line only for partnerships that have elected a simplified method.
For partnerships that have elected the simplified production method, additional section 263A costs are generally those costs, other than
interest, that were not capitalized under the partnership's method of accounting immediately prior to the effective date of section 263A that are
required to be capitalized under section 263A. Interest must be accounted for separately. For new partnerships, additional section 263A costs are the
costs, other than interest, that must be capitalized under section 263A, but which the partnership would not have been required to capitalize if it
had existed before the effective date of section 263A. For more details, see Regulations section 1.263A-2(b).
For partnerships that have elected the simplified resale method, additional section 263A costs are generally those costs incurred with
respect to the following categories:
- Off-site storage or warehousing.
- Purchasing.
- Handling, such as processing, assembly, repackaging, and transporting.
- General and administrative costs (mixed service costs).
For more details, see Regulations section 1.263A-3(d).
Enter on line 4 the balance of section 263A costs paid or incurred during the tax year not includable on lines 2, 3, and 5. Attach a schedule
listing these costs.
Line 5 - Other Costs
Enter on line 5 any other inventoriable costs paid or incurred during the tax year not entered on lines 2 through 4. Attach a schedule.
Line 7 - Inventory at End of Year
See Regulations sections 1.263A-1 through 1.263A-3 for details on figuring the amount of additional section 263A costs to be included in ending inventory.
If the partnership accounts for inventoriable items in the same manner as materials and supplies that are not incidental, enter on line 7 the
portion of its raw materials and merchandise purchased for resale that are included on line 6 and were not sold during the year.
Lines 9a through 9c - Inventory Valuation Methods
Inventories can be valued at:
- Cost,
- Cost or market value (whichever is lower), or
- Any other method approved by the IRS that conforms to the requirements of the applicable regulations.
However, the partnership is required to use cost if it is using the cash method of accounting.
Partnerships that account for inventoriable items in the same manner as material and supplies that are not incidental may currently deduct
expenditures for direct labor and all indirect costs that would otherwise be included in inventory costs.
The average cost (rolling average) method of valuing inventories generally does not conform to the requirements of the regulations. See Rev. Rul.
71-234, 1971-1 C.B. 148.
Partnerships that use erroneous valuation methods must change to a method permitted for Federal tax purposes. To make this change, use Form 3115.
On line 9a, check the methods used for valuing inventories. Under lower of cost or market, the term market (for normal goods) means the
current bid price prevailing on the inventory valuation date for the particular merchandise in the volume usually purchased by the taxpayer. For a
manufacturer, market applies to the basic elements of cost - raw materials, labor, and burden. If section 263A applies to the taxpayer, the basic
elements of cost must reflect the current bid price of all direct costs and all indirect costs properly allocable to goods on hand at the inventory
date.
Inventory may be valued below cost when the merchandise is unsalable at normal prices or unusable in the normal way because the goods are subnormal
due to damage, imperfections, shop wear, etc., within the meaning of Regulations section 1.471-2(c). These goods may be valued at the current bona
fide selling price minus the direct cost of disposition (but not less than scrap value) if such a price can be established.
If this is the first year the last-in first-out (LIFO) inventory method was either adopted or extended to inventory goods not previously valued
under the LIFO method, attach Form 970, Application To Use LIFO Inventory Method, or a statement with the information required by Form 970.
Also check the box on line 9c.
If the partnership has changed or extended its inventory method to LIFO and has had to write up its opening inventory to cost in the year of
election, report the effect of this write-up as income (line 7, page 1, Form 1065) proportionately over a 3-year period that begins in the tax year of
the LIFO election.
For more information on inventory valuation methods, see Pub. 538, Accounting Periods and Methods.
Schedule B - Other Information
Question 1
Check box 1(f) for any other type of entity and state the type.
Question 3
The partnership must answer Yes to Question 3, if during the tax year, it owned:
- An interest in another partnership (foreign or domestic) or
- A foreign entity that was disregarded as an entity separate from the partnership under Regulations sections 301.7701-2 and
301.7701-3.
If the partnership answered Yes to this question, report the following information on an attached schedule:
- If the partnership owned at least a 10% interest, directly or indirectly, in any other foreign or domestic partnership (other than any
partnership for which a Form 8865 is attached to the tax return), show each partnership's name, EIN (if any), and the country under whose laws the
partnership was organized.
- If the partnership owned any entities that have been disregarded as separate from the partnership, show each disregarded entity's name, EIN
(if any), and the country under whose laws the entity was organized.
Note:
For each entity listed on the attached schedule, clearly indicate whether the entity is a partnership or a disregarded entity.
Question 4 - Consolidated Audit Procedures
Generally, the tax treatment of partnership items is determined at the partnership level in a consolidated audit proceeding, rather than in
separate proceedings with individual partners.
Answer Yes to Question 4 if any of the following apply:
- The partnership had more than 10 partners at any one time during the tax year. For purposes of this question, a husband and wife, and their
estates, count as one person.
- Any partner was a nonresident alien or was other than an individual, an estate, or a C corporation.
- The partnership is a small partnership that has elected to be subject to the rules for consolidated audit proceedings. Small
partnerships as defined in section 6231(a)(1)(B)(i) are not subject to the rules for consolidated audit proceedings unless an election to be
covered by them is made under Regulations section 301.6231(a)(1)-1(b)(2). Once made, the election may not be revoked without IRS consent.
The partnership does not make this election when it answers Yes to Question 4. The election must be made separately.
If a partnership return is filed by an entity for a tax year, but it is determined that the entity is not a partnership for that tax year, the
consolidated partnership audit procedures will generally apply to that entity and to persons holding an interest in that entity. See Regulations
section 301.6233-1 for details and exceptions.
Question 6 - Foreign Partners
Answer Yes to Question 6 if the partnership had any foreign partners (for purposes of section 1446) at any time during the tax year.
Otherwise, answer No.
If the partnership had gross income effectively connected with a trade or business in the United States and foreign partners, it may be
required to withhold tax under section 1446 on income allocable to foreign partners (without regard to distributions) and file Forms 8804, 8805, and
8813.
Question 7
Answer Yes to Question 7 if interests in the partnership are traded on an established securities market or are readily tradable on a
secondary market (or its substantial equivalent).
Question 8
Organizers of certain tax shelters are required to
register the tax shelters by filing Form 8264, Application for Registration of a Tax Shelter, no
later than the day on which an interest in the shelter is first offered for sale. Organizers filing a properly completed Form 8264 will receive a tax
shelter registration number that they must furnish to their investors. See the Instructions for Form 8264 for the definition of a tax shelter and the
investments exempted from tax shelter registration.
Question 9 - Foreign Accounts
Answer Yes to Question 9 if either 1 or 2 below applies to the partnership. Otherwise, check the No
box.
- At any time during calendar year 2001, the partnership had an interest in or signature or other authority over a bank account, securities
account, or other financial account in a foreign country; and
- The combined value of the accounts was more than $10,000 at any time during the calendar year; and
- The accounts were not with a U.S. military banking facility operated by a U.S. financial institution.
- The partnership owns more than 50% of the stock in any corporation that would answer the question Yes based on item 1
above.
Get Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts, to see if the partnership is considered to have an interest in or
signature or other authority over a bank account, securities account, or other financial account in a foreign country.
If you answered Yes to Question 9, file Form TD F 90-22.1 by June 30, 2002, with the Department of the Treasury at the address shown on
the form. Because Form TD F 90-22.1 is not a tax return, do not file it with Form 1065. You may order Form TD F 90-22.1 by calling
1-800-829-3676.
Question 10
The partnership may be required to file
Form 3520, Annual Return To Report Transactions With Foreign Trusts and Receipt of
Certain Foreign Gifts, if:
- It directly or indirectly transferred property or money to a foreign trust. For this purpose, any U.S. person who created a foreign trust is
considered a transferor.
- It is treated as the owner of any part of the assets of a foreign trust under the grantor trust rules.
- It received a distribution from a foreign trust.
For more information, see the Instructions for Form 3520.
Note:
An owner of a foreign trust must ensure that the trust files an annual information return on Form 3520-A, Annual Information Return of
Foreign Trust with a U.S. Owner.
Designation of Tax Matters Partner (TMP)
If the partnership is subject to the rules for consolidated audit proceedings in sections 6221 through 6233, the partnership may designate a
partner as the TMP for the tax year for which the return is filed by completing the Designation of Tax Matters Partner section on page 2 of
Form 1065. See the instructions for Question 4, consolidated audit procedures, to determine if the partnership is subject to these rules. The
designated TMP must be a general partner and, in most cases, must also be a U.S. person. For details, see Regulations section 301.6231(a)(7)-1.
For a limited liability company (LLC), only a member-manager of the LLC is treated as a general partner. A member-manager is any owner of an
interest in the LLC who, alone or together with others, has the continuing exclusive authority to make the management decisions necessary to conduct
the business for which the LLC was formed. If there are no elected or designated member-managers, each owner is treated as a member-manager. For
details, see Regulations section 301.6231(a)(7)-2.
Schedules K and K-1 - Partners' Shares of Income, Credits, Deductions, etc.
Purpose of Schedules
Although the partnership is not subject to income tax, the partners are liable for tax on their shares of the partnership income, whether or not
distributed, and must include their shares on their tax returns.
Schedule K
(page 3 of Form 1065) is a summary schedule of all the partners' shares of the partnership's income, credits, deductions, etc. All partnerships
must complete Schedule K. Rental activity income (loss) and portfolio income are not reported on page 1 of Form 1065. These amounts are not combined
with trade or business activity income (loss). Schedule K is used to report the totals of these and other amounts.
Schedule K-1
(Form 1065) shows each partner's separate share. Attach a copy of each Schedule K-1 to the Form 1065 filed with the IRS; keep a copy with a copy of
the partnership return as a part of the partnership's records; and furnish a copy to each partner. If a partnership interest is held by a nominee on
behalf of another person, the partnership may be required to furnish Schedule K-1 to the nominee. See Temporary Regulations sections 1.6031(b)-1T and
1.6031(c)-1T for more information.
Give each partner a copy of either the Partner's Instructions for Schedule K-1 (Form 1065) or specific instructions for each item reported on the
partner's Schedule K-1 (Form 1065).
Substitute Forms
The partnership does not need IRS approval to use a substitute Schedule K-1 if it is an exact copy of the IRS schedule, or if it contains only
those lines the taxpayer is required to use. The lines must use the same numbers and titles and must be in the same order and format as on the
comparable IRS Schedule K-1. The substitute schedule must include the OMB number. The partnership must provide each partner with the Partner's
Instructions for Schedule K-1 (Form 1065) or other prepared specific instructions.
The partnership must request IRS approval to use other substitute Schedules K-1. To request approval, write to Internal Revenue Service, Attention:
Substitute Forms Program, W:CAR:MP:FP:S:SP, 1111 Constitution Avenue, NW, Washington, DC 20224.
Each partner's information must be on a separate sheet of paper. Therefore, separate all continuously printed substitutes before you file them with
the IRS.
The partnership may be subject to a penalty if it files Schedules K-1 that do not conform to the specifications of Rev. Proc. 2000-19, 2000-12
I.R.B. 785.
How Income Is Shared Among Partners
Allocate shares of income, gain, loss, deduction, or credit among the partners according to the partnership agreement for sharing income or loss
generally. Partners may agree to allocate specific items in a ratio different from the ratio for sharing income or loss. For instance, if the net
income exclusive of specially allocated items is divided evenly among three partners but some special items are allocated 50% to one, 30% to another,
and 20% to the third partner, report the specially allocated items on the appropriate line of the applicable partner's Schedule K-1 and the total on
the appropriate line of Schedule K, instead of on the numbered lines on page 1 of Form 1065 or Schedules A or D.
If a partner's interest changed during the year, see section 706(d) before determining each partner's distributive share of any item of income,
gain, loss, deduction, etc. Income (loss) is allocated to a partner only for the part of the year in which that person is a member of the partnership.
The partnership will either allocate on a daily basis or divide the partnership year into segments and allocate income, loss, or special items in each
segment among the persons who were partners during that segment. Partnerships that report their income on the cash basis must allocate interest
expense, taxes, and any payment for services or for the use of property on a daily basis if there is any change in any partner's interest during the
year. See Pub. 541 for more details.
Special rules on the allocation of income, gain, loss, and deductions generally apply if a partner
contributes property to the partnership and the FMV of that property at the time of contribution differs from the contributing partner's adjusted tax
basis. Under these rules, the partnership must use a reasonable method of making allocations of income, gain, loss, and deductions from the property
so that the contributing partner receives the tax burdens and benefits of any built-in gain or loss (i.e., precontribution appreciation or diminution
of value of the contributed property). See Regulations section 1.704-3 for details on how to make these allocations, including a description of
specific allocation methods that are generally reasonable.
See Dispositions of Contributed Property on page 8 for special rules on the allocation of income, gain, loss, and deductions on the
disposition of property contributed to the partnership by a partner.
If the partnership agreement does not provide for the partner's share of income, gain, loss, deduction, or credit, or if the allocation under the
agreement does not have substantial economic effect, the partner's share is determined according to the partner's interest in the partnership. See
Regulations section 1.704-1 for more information.
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