6.4 Pass-Through Income on Schedule K-1: Partner and S Shareholder Basis, At-Risk, Excess Business Loss & Publicly Traded Partnerships
Key Takeaways
- Items from Schedule K-1 retain their character and are reported on the owner's return: ordinary business income on Schedule E, Part II; interest, dividends, and capital gains on their usual schedules; and guaranteed payments and a general partner's share of business income as self-employment income.
- A pass-through loss is tested in order against the owner's basis (IRC §704(d) or §1366(d)), at-risk amount (IRC §465, Form 6198), passive activity rules (IRC §469, Form 8582), and the excess business loss limit (IRC §461(l), Form 461).
- An S corporation shareholder's debt basis includes only loans the shareholder personally made to the corporation, not corporate debt the shareholder guarantees, and shareholders who claim losses or receive distributions must file Form 7203.
- For 2025, a noncorporate taxpayer's net business losses in excess of $313,000 ($626,000 joint) are disallowed as an excess business loss and carried forward as a net operating loss.
- Losses from a publicly traded partnership can offset only income from the same PTP until the entire interest is sold, and part of the gain on a PTP sale is often ordinary income under IRC §751 that the Form 1099-B does not reflect.
Why This Topic Matters
The Income and Assets domain lists "Pass-through income (e.g., Schedule K-1, income, deductions, basis, qualified business income [QBI] items)" and "Publicly traded partnerships (PTP) (e.g., sales, dispositions, losses)." Part 1 approaches pass-throughs from the owner's side: reporting the K-1 correctly and deciding how much of a loss the owner can deduct this year.
Reporting the Schedule K-1
| K-1 From | Common Items and Where They Go |
|---|---|
| Partnership or multi-member LLC (Form 1065) | Ordinary business income or loss and net rental income or loss: Schedule E, Part II. Guaranteed payments: Schedule E and self-employment income (Schedule SE). A general partner's share of ordinary business income is SE income (Box 14); a limited partner's is not, except guaranteed payments for services. Interest, dividends, and capital gains: Schedule B and Schedule D. Section 199A information: Box 20, Code Z |
| S corporation (Form 1120-S) | Ordinary income or loss: Schedule E, Part II. Not SE income; the shareholder-employee's salary is on a Form W-2. Distributions are not income unless they exceed stock basis. Section 199A information: Box 17, Code V |
| Estate or trust (Form 1041) | Distributable net income by character: interest, dividends, capital gains, rental income, and so on, reported on the matching schedules; beneficiaries report Schedule E, Part III items |
Each item keeps its character: a partner's share of a partnership's qualified dividends is a qualified dividend on the partner's return, and a partner's share of charitable contributions is an itemized deduction on Schedule A.
The Four Loss Limitations, in Order
A pass-through loss must pass each test in sequence; a loss suspended at one level never reaches the next:
- Basis (IRC §704(d) for partners; §1366(d) for S shareholders): Loss is deductible only to the extent of the owner's basis. Suspended losses carry forward indefinitely until basis is restored.
- At-risk (IRC §465, Form 6198): Loss is further limited to the amount the owner could actually lose: cash and property contributed plus debt for which the owner is personally liable (and qualified nonrecourse financing for real estate).
- Passive activity (IRC §469, Form 8582): If the owner does not materially participate, the loss can offset only passive income (with the $25,000 rental exception for active participants).
- Excess business loss (IRC §461(l), Form 461): For 2025, total net business losses above $313,000 ($626,000 joint) are disallowed and become part of the taxpayer's net operating loss carryforward. OBBBA made this limit permanent.
Partner Basis (Outside Basis)
| Increases | Decreases (not below zero) |
|---|---|
| Cash and the adjusted basis of property contributed | Cash and the basis of property distributed |
| Share of partnership taxable and tax-exempt income | Share of losses and nondeductible expenses |
| Increase in share of partnership liabilities (recourse and nonrecourse) | Decrease in share of partnership liabilities (treated as a cash distribution) |
Because a partner's basis includes a share of partnership debt, partners can often deduct losses beyond their cash investment. A cash distribution in excess of basis is capital gain.
S Corporation Shareholder Basis
- Stock basis: Increases for contributions and income; decreases for distributions, losses, and nondeductible expenses.
- Debt basis: Only for loans the shareholder personally made to the corporation. A shareholder's guarantee of a bank loan to the corporation does not create basis.
- Losses reduce stock basis first, then debt basis; distributions reduce only stock basis. A distribution exceeding stock basis is capital gain.
- Form 7203 must be attached when an S shareholder claims a loss, receives a nondividend distribution, disposes of stock, or receives a loan repayment.
Example (loss ordering): In 2025, Hana is a limited partner in a partnership that invests in equipment leasing. Her basis is $30,000, including a $10,000 share of nonrecourse debt that is not qualified nonrecourse financing, so her at-risk amount is $20,000. She does not materially participate and has no other passive income. Her K-1 shows a $45,000 ordinary loss.
- Basis: $30,000 allowed; $15,000 suspended under §704(d).
- At-risk: Of the $30,000, only $20,000 passes; $10,000 suspended under §465.
- Passive: The remaining $20,000 is passive with no passive income to absorb it; $20,000 suspended on Form 8582.
- Excess business loss: Not reached. Hana deducts $0 this year and tracks three separate carryforwards.
Publicly Traded Partnerships (PTPs)
A publicly traded partnership is a partnership whose units trade on an established securities market (many energy pipeline MLPs). Investors receive a Schedule K-1, not a Form 1099-DIV.
- Separate passive basket (IRC §469(k)): Net losses from a PTP can offset only income from the same PTP in later years. PTP income cannot absorb losses from other passive activities, and other passive income cannot absorb PTP losses.
- Full disposition: When the investor sells the entire interest in a PTP in a fully taxable transaction, suspended PTP losses are released and deductible in full.
- Sale of units: Because cash distributions reduce basis and the investor's share of losses has reduced it further, the adjusted basis is often far below the purchase price. Form 1099-B usually reports the original cost, which must be adjusted using the K-1 sales schedule. Part of the gain is ordinary income under IRC §751 (from depreciation recapture and other "hot assets"), reported on Form 4797; the rest is capital gain.
- QBI: Qualified PTP income qualifies for the 20% Section 199A deduction without the W-2 wage and property limits (computed with qualified REIT dividends).
Example (PTP sale): Leo bought PTP units for $20,000. Over the years, distributions and losses reduced his basis to $8,000, and $3,000 of PTP losses remain suspended. He sells all his units in 2025 for $24,000. His total gain is $16,000, of which the K-1 sales schedule shows $9,000 as §751 ordinary income and $7,000 as long-term capital gain. The $3,000 suspended loss is released on the complete disposition.
Ruth owns 40% of an S corporation. At the start of 2025 her stock basis is $12,000, and she personally guaranteed a $50,000 bank loan to the corporation. She has lent the corporation nothing herself. Her 2025 K-1 shows a $30,000 ordinary loss. She materially participates. How much of the loss can she deduct for 2025?
Nadia owns units in two publicly traded partnerships. In 2025, PTP A allocates her a $4,000 loss and PTP B allocates her $6,000 of income. She has no other passive activities and still owns both. How are these items treated?
For 2025, Wes, who is single, has $900,000 of wages and a $500,000 net loss from a sole proprietorship in which he materially participates. He has no other business income or losses. How much of the business loss can he deduct against his wages in 2025?