Schedule B - Income Statement - Trade or Business Income

Important:   If the foreign partnership filed Form 1065 or 1065-B, do not complete Schedule B on Form 8865. Instead, attach to Form 8865 a copy of page 1 from Form 1065, or Parts I and II of Form 1065-B.

All Category 1 filers must complete Schedule B and also report the amounts on Schedules K and K-1.

Income

Report only trade or business activity income on lines 1a through 8. Do not report rental activity income or portfolio income on these lines. Rental activity income and portfolio income are reported on Schedules K and K-1. Rental real estate activities are also reported on Form 8825, Rental Real Estate Income and Expenses of a Partnership or an S Corporation.

Do not include any tax-exempt income on lines 1a through 7. A partner in a partnership that receives any tax-exempt income other than interest, or holds any property or engages in any activity that produces tax-exempt income reports the amount of this income on line 20 of Schedules K and K-1.

Report tax-exempt interest income, including exempt-interest dividends received by the partnership as a shareholder in a mutual fund or other regulated investment company, on line 19 of Schedules K and K-1.

See Deductions on page 7 for information on how to report expenses related to tax-exempt income.

If the partnership has had debt discharged resulting from a title 11 bankruptcy proceeding or while insolvent, see Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, and Pub. 908, Bankruptcy Tax Guide.

Line 1a - Gross Receipts or Sales

Enter the gross receipts or sales from all trade or business operations except those that must be reported on lines 4 through 7. For example, do not include gross receipts from farming on this line. Instead, show the net profit (loss) from farming on line 5. Also, do not include on line 1a rental activity income or portfolio income.

In general, advance payments are reported in the year of receipt. To report income from long-term contracts, see section 460. For special rules for reporting certain advance payments for goods and long-term contracts, see Regulations section 1.451-5. For permissible methods for reporting advance payments for services by an accrual method partnership, see Rev. Proc. 71-21, 1971-2 C.B. 549.

Installment sales.   Generally, the installment method cannot be used for dealer dispositions of property. A dealer disposition is any disposition of personal property by a person who regularly sells or otherwise disposes of personal property of the same type on the installment plan or any disposition of real property held for sale to customers in the ordinary course of the taxpayer's trade or business. The disposition of property used or produced in a farming business is not included as a dealer disposition. See section 453(l) for details and exceptions.

Enter on line 1a the gross profit on collections from installment sales for any of the following:

• Dealer dispositions of property before March 1, 1986.
• Dispositions of property used or produced in the trade or business of farming.
• Dispositions of timeshares and residential lots reported under the installment method.

Attach a schedule showing the following information for the current year and the 3 preceding years:

• Gross sales.
• Cost of goods sold.
• Gross profits.
• Percentage of gross profits to gross sales.
• Amount collected.
• Gross profit on amount collected.

Line 2 - 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 or a qualifying small business taxpayer, it may account for inventory items in the same manner as materials and supplies that are not incidental.

A qualifying taxpayer is a taxpayer

1. whose average annual gross receipts for the 3 prior tax years are $1 million or less and
2. whose business is not a tax shelter (as defined in section 448(d)(3)).

See Rev. Proc. 2001-10, 2001-2 I.R.B. 272 for details.

A qualifying small business taxpayer is a taxpayer

1. whose average annual gross receipts for the 3 prior tax years are more than $1 million but not more than $10 million,
2. whose business is not a tax shelter (as defined in section 448(d)(3)), and
3. whose principal business activity is not an ineligible activity as explained in Rev. Proc. 2002-28.

Under this accounting method, inventory costs for raw materials purchased for use in producing finished goods or 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).

Cost of Goods Sold Worksheet Instructions.   All filers not using the cash method of accounting should see Section 263A uniform capitalization rules on page 8 before completing the worksheet.

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 - Other Costs.   Enter on line 4 any costs paid or incurred during the tax year not entered on lines 2 and 3.

Line 4 - Ordinary Income (Loss) From Other Partnerships, Estates, and Trusts

Enter the ordinary income (loss) shown on Schedule K-1 (Form 1065) or Schedule K-1 (Form 1041), or other ordinary income (loss) from a foreign partnership, estate, or trust. Show the partnership's, estate's, or trust's name, address, and EIN on a separate statement attached to this return. If the amount entered is from more than one source, identify the amount from each source.

Do not include portfolio income or rental activity income (loss) from other partnerships, estates, or trusts on this line. Instead, report these amounts on the applicable lines of Schedules K and K-1, or on line 20a of Form 8825 if the amount is from a rental real estate activity.

Ordinary income or loss from another partnership that is a publicly traded partnership is not reported on this line. Instead, report the amount separately on line 7 of Schedules K and K-1.

Cost of Goods Sold Worksheet

Treat shares of other items separately reported on Schedule K-1 issued by the other entity as if the items were realized or incurred by this partnership.

If there is a loss from another partnership, the amount of the loss that may be claimed is subject to the at-risk and basis limitations as appropriate.

If the tax year of your partnership does not coincide with the tax year of the other partnership, estate, or trust, include the ordinary income (loss) from the other entity in the tax year in which the other entity's tax year ends.

Line 5 - Net Farm Profit (Loss)

Enter the partnership's net farm profit (loss) from Schedule F (Form 1040), Profit or Loss From Farming. Attach Schedule F (Form 1040) to Form 8865. Do not include on this line any farm profit (loss) from other partnerships. Report those amounts on line 4.

Also report the partnership's fishing income on this line.

For a special rule concerning the method of accounting for a farming partnership with a corporate partner and for other tax information on farms, see Pub. 225, Farmer's Tax Guide.

Note:    Farm partnerships that are not required to use an accrual method should not capitalize the expenses of raising any plant with a preproductive period of more than 2 years. Instead, state them separately on an attachment to Schedule K, line 24, and on Schedule K-1, line 25, Supplemental Information. See Regulations section 1.263A-4 for more information.

Line 6 - Net Gain (Loss) From Form 4797

Include only ordinary gains or losses from the sale, exchange, or involuntary conversion of assets used in a trade or business activity. Ordinary gains or losses from the sale, exchange, or involuntary conversion of rental activity assets are reported separately on line 19 of Form 8825 or line 3 of Schedules K and K-1, generally as a part of the net income (loss) from the rental activity.

For a partnership that is a partner in another partnership, include on Form 4797, Sales of Business Property, this partnership's share of ordinary gains (losses) from sales, exchanges, or involuntary conversions (other than casualties or thefts) of the other partnership's trade or business assets.

Do not include any recapture of section 179 expense deduction. See the instructions for Schedule K-1, line 25, Supplemental Information, item 4, and the Instructions for Form 4797 for more information.

Line 7 - Other Income (Loss)

Enter on line 7 trade or business income (loss) that is not included on lines 1a through 6. Examples of such income include:

1. Interest income derived in the ordinary course of the partnership's trade or business, such as interest charged on receivable balances.
2. Recoveries of bad debts deducted in earlier years under the specific charge-off method.
3. Taxable income from insurance proceeds.
4. The amount of credit figured on Form 6478, Credit for Alcohol Used as Fuel.
5. All section 481 income adjustments resulting from changes in accounting methods. Show the computation of the section 481 adjustments on an attached schedule.
6. The amount of any deduction previously taken under section 179A that is subject to recapture. See Pub. 535, Business Expenses, for details, including how to figure the recapture.
7. The recapture amount for section 280F if the business use of listed property drops to 50% or less. To figure the recapture amount, complete Part IV of Form 4797.

Do not include items requiring separate computations that must be reported on Schedules K and K-1. See the instructions for Schedules K and K-1 later in these instructions.

Do not report portfolio or rental activity income (loss) on this line.

Deductions

Report only trade or business activity deductions on lines 9 through 21.

Do not report the following expenses on lines 9 through 21:

• Rental activity expenses. Report these expenses on Form 8825 or line 3b of Schedule K.
• Deductions allocable to portfolio income. Report these deductions on line 10 of Schedules K and K-1.
• Nondeductible expenses (e.g., expenses connected with the production of tax-exempt income). Report nondeductible expenses on line 21 of Schedules K and K-1.
• Qualified expenditures to which an election under section 59(e) may apply. The instructions for lines 18a and 18b of Schedules K and K-1 explain how to report these amounts.
• Items that require separate computations by the partners. Examples include expenses incurred for the production of income instead of in a trade or business, charitable contributions, foreign taxes paid, intangible drilling and development costs, soil and water conservation expenditures, amortizable basis of reforestation expenditures, and exploration expenditures. The distributive shares of these expenses are reported separately on Schedule K-1.

Limitations on Deductions

Section 263A uniform capitalization rules.   The uniform capitalization rules of section 263A require partnerships to capitalize or include in inventory costs, certain costs incurred in connection with:

• The production of real and tangible personal property held in inventory or held for sale in the ordinary course of business.
• Real property or personal property (tangible and intangible) acquired for resale.
• The production of real property and tangible personal property by a partnership for use in its trade or business or in an activity engaged in for profit.

The costs required to be capitalized under section 263A are not deductible until the property to which the costs relate is sold, used, or otherwise disposed of by the partnership.

Exceptions.   Section 263A does not apply to:

• Inventory of a partnership that accounts for inventories in the same manner as materials and supplies that are not incidental.
• Personal property acquired for resale if the partnership's average annual gross receipts for the 3 prior tax years were $10 million or less.
• Timber.
• Most property produced under a long-term contract.
• Certain property produced in a farming business. See the note at the end of the instructions for line 5 on page 7.

Report the following costs separately for purposes of determinations under section 59(e):

• Research and experimental costs under section 174.
• Intangible drilling costs for oil, gas, and geothermal property.
• Mining exploration and development costs.

Tangible personal property produced by a partnership includes a film, sound recording, videotape, book, or similar property.

Partnerships subject to the rules are required to capitalize not only direct costs but an allocable part of most indirect costs (including taxes) that benefit the assets produced or acquired for resale, or are incurred by reason of the performance of production or resale activities.

For inventory, some of the indirect costs that must be capitalized are:

• Administration expenses.
• Taxes.
• Depreciation.
• Insurance.
• Compensation paid to officers attributable to services.
• Rework labor.
• Contributions to pension, stock bonus, and certain profit-sharing, annuity, or deferred compensation plans.

Regulations section 1.263A-1(e)(3) specifies other indirect costs that relate to production or resale activities that must be capitalized and those that may be currently deductible.

Interest expense paid or incurred during the production period of designated property must be capitalized and is governed by special rules. For more details, see Regulations sections 1.263A-8 through 1.263A-15.

For more details on the uniform capitalization rules, see Regulations sections 1.263A-1 through 1.263A-3.

Transactions between related taxpayers.   Generally, an accrual basis partnership may deduct business expenses and interest owed to a related party (including any partner) only in the tax year of the partnership that includes the day on which the payment is includible in the income of the related party. See section 267 for details.

Business start-up expenses.   Business start-up expenses must be capitalized. If the partnership files Form 1065 or 1065-B, it may elect to amortize them over a period of not less than 60 months. See Pub. 535 and Regulations section 1.195-1.

Organization costs.   Amounts paid or incurred to organize a partnership are capital expenditures. They are not deductible as a current expense.

If the partnership files Form 1065 or 1065-B, it may elect to amortize organization expenses over a period of 60 or more months, beginning with the month in which the partnership begins business. See the instructions for line 10 for the treatment of organization expenses paid to a partner. See Pub. 535 for more information.

Syndication costs.   Costs for issuing and marketing interests in the partnership, such as commissions, professional fees, and printing costs, must be capitalized. They cannot be depreciated or amortized. See the instructions for line 10 for the treatment of syndication fees paid to a partner.

Reducing certain expenses for which credits are allowable.   For each of the following credits, the partnership must reduce the otherwise allowable deductions for expenses used to figure the credit by the amount of the current year credit:

1. The work opportunity credit.
2. The welfare-to-work credit.
3. The credit for increasing research activities.
4. The enhanced oil recovery credit.
5. The disabled access credit.
6. The empowerment zone and renewal community employment credit.
7. The Indian employment credit.
8. The credit for employer social security and Medicare taxes paid on certain employee tips.
9. The orphan drug credit.

If the partnership has any of these credits, figure each current year credit before figuring the deductions for expenses on which the credit is based.

Line 9 - Salaries and Wages

Enter on line 9 the salaries and wages paid or incurred for the tax year, reduced by any applicable employment credits from Form 5884, Work Opportunity Credit, Form 8861, Welfare-to-Work Credit, Form 8844, Empowerment Zone and Renewal Community Employment Credit, and Form 8845, Indian Employment Credit. See the instructions for these forms for more information.

Do not include salaries and wages reported elsewhere on the return, such as amounts included in cost of goods sold, elective contributions to a section 401(k) cash or deferred arrangement, or amounts contributed under a salary reduction SEP agreement or a SIMPLE IRA plan.

Line 10 - Guaranteed Payments to Partners

Deduct payments or credits to a partner for services or for the use of capital if the payments or credits are determined without regard to partnership income and are allocable to a trade or business activity. Also include on line 10 amounts paid during the tax year for insurance that constitutes medical care for a partner, a partner's spouse, or a partner's dependents.

Do not include any payments and credits that should be capitalized. For example, although payments or credits to a partner for services rendered in organizing or syndicating a partnership may be guaranteed payments, they are not deductible on line 10. They are capital expenditures. However, they should be separately reported on Schedules K and K-1, line 5.

Do not include distributive shares of partnership profits.

Report the guaranteed payments to the appropriate partners on Schedule K-1, line 5.

Line 11 - Repairs and Maintenance

Enter the costs of incidental repairs and maintenance that do not add to the value of the property or appreciably prolong its life, but only to the extent that such costs relate to a trade or business activity and are not claimed elsewhere on the return.

New buildings, machinery, or permanent improvements that increase the value of the property are not deductible. They are chargeable to capital accounts and may be depreciated or amortized.

Line 12 - Bad Debts

Enter the total debts that became worthless in whole or in part during the year, but only to the extent such debts relate to a trade or business activity. Report deductible nonbusiness bad debts as a short-term capital loss on Schedule D.

Cash method partnerships cannot take a bad debt deduction unless the amount was previously included in income.

Line 13 - Rent

Enter rent paid on business property used in a trade or business activity. Do not deduct rent for a dwelling unit occupied by any partner for personal use.

If the partnership rented or leased a vehicle, enter the total annual rent or lease expense paid or incurred in the trade or business activities of the partnership. Also complete Part V of Form 4562, Depreciation and Amortization. If the partnership leased a vehicle for a term of 30 days or more, the deduction for vehicle lease expense may have to be reduced by an amount called the inclusion amount. You may have an inclusion amount if:

The lease term began:	And the vehicle's fair market value on the first day of the lease exceeded:
After 12/31/98	$15,500
After 12/31/96 but before 1/1/99	$15,800
After 12/31/94 but before 1/1/97	$15,500
If the lease term began before January 1, 1995, see Pub. 463, Travel, Entertainment, Gift, and Car Expenses, to find out if the partnership has an inclusion amount.

See Pub. 463 for instructions on figuring the inclusion amount.

Line 14 - Taxes and Licenses

Enter taxes and licenses paid or incurred in the trade or business activities of the partnership if not reflected in cost of goods sold. Federal import duties and Federal excise and stamp taxes are deductible only if paid or incurred in carrying on the trade or business of the partnership.

Do not deduct the following taxes on line 14:

• State and local sales taxes paid or incurred in connection with the acquisition or disposition of business property. These taxes must be added to the cost of the property, or, in the case of a disposition, subtracted from the amount realized.
• Taxes assessed against local benefits to the extent that they increase the value of the property assessed, such as for paving, etc.
• Federal income taxes or taxes reported elsewhere on the return.
• Section 901 foreign taxes. See Schedules K and K-1, line 17g.
• Taxes allocable to a rental activity. Taxes allocable to a rental real estate activity are reported on Form 8825. Taxes allocable to a rental activity other than a rental real estate activity are reported on line 3b of Schedule K.
• Taxes allocable to portfolio income. These taxes are reported on line 10 of Schedules K and K-1.
• Taxes paid or incurred for the production or collection of income, or for the management, conservation, or maintenance of property held to produce income. Report these taxes separately on line 11 of Schedules K and K-1.

See section 263A(a) for rules on capitalization of allocable costs (including taxes) for any property.

Line 15 - Interest

Include only interest incurred in the trade or business activities of the partnership that is not claimed elsewhere on the return.

Do not deduct interest expense on debt required to be allocated to the production of designated property. Designated property includes real property, personal property that has a class life of 20 years or more, and other tangible property requiring more than 2 years (1 year in the case of property with a cost of more than $1 million) to produce or construct. Interest that is allocable to designated property produced by a partnership for its own use or for sale must be capitalized.

In addition, a partnership must also capitalize any interest on debt that is allocable to an asset used to produce designated property. A partner may be required to capitalize interest that was incurred by the partner for the partnership's production expenditures. Similarly, a partner may have to capitalize interest that was incurred by the partnership for the partner's own production expenditures. The information required by the partner to properly capitalize interest for this purpose must be provided by the partnership in an attachment to Schedule K-1. See section 263A(f) and Regulations sections 1.263A-8 through 1.263A-15.

Do not include interest expense on debt used to purchase rental property or debt used in a rental activity. Interest allocable to a rental real estate activity is reported on Form 8825 and is used in arriving at net income (loss) from rental real estate activities on line 2 of Schedules K and K-1. Interest allocable to a rental activity other than a rental real estate activity is included on line 3b of Schedule K and is used in arriving at net income (loss) from a rental activity (other than a rental real estate activity). This net amount is reported on line 3c of Schedule K and line 3 of Schedule K-1.

Do not include interest expense on debt used to buy property held for investment. Do not include interest expense that is clearly and directly allocable to interest, dividend, royalty, or annuity income not derived in the ordinary course of a trade or business. Interest paid or incurred on debt used to purchase or carry investment property is reported on line 14a of Schedules K and K-1. See the instructions for line 14a of Schedules K and K-1 and Form 4952, Investment Interest Expense Deduction, for more information on investment property.

Do not include interest on debt proceeds allocated to distributions made to partners during the tax year. Instead, report such interest on line 11 of Schedules K and K-1. To determine the amount to allocate to distributions to partners, see Notice 89-35, 1989-1 C.B. 675.

Temporary Regulations section 1.163-8T gives rules for allocating interest expense among activities so that the limitations on passive activity losses, investment interest, and personal interest can be properly figured. Generally, interest expense is allocated in the same manner that debt is allocated. Debt is allocated by tracing disbursements of the debt proceeds to specific expenditures, as provided in the regulations.

Interest paid by a partnership to a partner for the use of capital should be entered on line 10 as guaranteed payments.

Prepaid interest can only be deducted over the period to which the prepayment applies.

Note:   Additional limitations on interest deductions apply when the partnership is a policyholder or beneficiary with respect to a life insurance, endowment, or annuity contract issued after June 8, 1997. For details, see section 264. Attach a statement showing the computation of the deduction disallowed under section 264.

Line 16 - Depreciation

On line 16a, enter only the depreciation claimed on assets used in a trade or business activity. Enter on line 16b the depreciation reported elsewhere on the return that is attributable to assets used in trade or business activities. See the Instructions for Form 4562 or Pub. 946, How To Depreciate Property, to figure the amount of depreciation to enter on this line.

For depreciation, you must complete and attach Form 4562 only if the partnership placed property in service during the tax year or claims depreciation on any car or other listed property.

Line 17 - Depletion

If the partnership claims a deduction for timber depletion, complete and attach Form T, Forest Activities Schedules.

Do not deduct depletion for oil and gas properties. The partner figures depletion on oil and gas properties. See the instructions for Schedule K-1, line 25, item 3.

Line 18 - Retirement Plans, etc.

Do not deduct payments for partners to retirement or deferred compensation plans including IRAs, qualified plans, and simplified employee pension (SEP) and SIMPLE IRA plans on this line. These amounts are reported on Schedule K-1, line 11, and are deducted by the partners on their own returns.

Enter the deductible contributions not claimed elsewhere on the return made by the partnership for its common-law employees under a qualified pension, profit-sharing, annuity, or SEP or SIMPLE IRA plan, and under any other deferred compensation plan.

If the partnership contributes to an individual retirement arrangement (IRA) for employees, include the contribution in salaries and wages on Schedule B, line 9, or Schedule B, line 2, and not on line 18.

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