Workaround for Bug: Schedule E Incorrectly Reporting Partner's Non-Passive Income from K-1

[beanorama1]

TurboTax Home & Business (Windows) is incorrectly reporting the share of income from a partner's K-1. But there is a workaround.

The Bug: Schedule E misstates non-passive income reported on a partners' K-1. On line 28, column (k), it should be reporting the partner's share of business income from line 1 from the partner's K-1. (See IRS' 2020 Partner's Instructions Schedule K-1 i1065sk1.pdf, p21.) Instead, it is reporting the self-employment earnings from K-1 line 14A.

For many partners, the amount of the share of income (line 1) and the amount of self-employment earnings (line 14A) will be the same. But not for all partners. In this case, the partnership makes a guaranteed payment to the partner. Self-employed earnings for this partner are greater than the partners' share of income. This error caused an overstatement of the partner's share of income and increased the partner's tax liability.

There is a workaround. Over-riding the incorrect amount in Schedule E would work, but is not preferred. TurboTax reports the override as an "error" on review and then prohibits e-filing, which is unacceptable.

Yet correcting the amount at the "Data source" works (right-click the data field for a pull-down menu). The source of the data is found on the K-1 Worksheet TurboTax creates for the partner, Section C, "Income and Loss Reported on Schedule E, Supplemental Income or Loss." Correcting the amount there with an override does not create an error. It will then report the correct amount to Schedule E.

Before I found the workaround, I had four different support calls with TurboTax representatives. I have been escalated to a "certified professional" at least once in those calls. In each call, using screenshare, the representative could see and acknowledge the error. Each one said they would report the bug and promised that someone would be in contact with me regarding the error, and if it was confirmed, providing me with an estimate on when it would be fixed. I was never contacted.

TurboTax support has been no help in resolving this error. I don't know why I didn't find the workaround before (though it is possible it wasn't possible in earlier versions and was introduced in an update).

[beanorama1]

This bug still exists in TurboTax Home & Business 2021 (Windows). The workaround still works.

There isn't a 2021 version of the Partner's Instructions for Schedule K-1 (Form 1065) yet. If a version is published for 2021, I'll try to remember to post here if anything changes.

[beanorama1 · Accepted solution]

The bug still exists.

There's a new 2021 version of the Partner's Instructions for Schedule K-1 (Form 1065) available and it confirms what's been true for years now: the correct amount to be reported on Schedule E, line 28, column (k), as required by the Partner's Instructions, is Ordinary business income from Schedule K-1, line 1. TurboTax instead is still incorrectly taking the amount from line 14. In the case of this partner, if I had not caught it, TurboTax would have cost this partner more than $3000 in taxes that were not due.

[beanorama]

Three tax years running, TurboTax still has this same bug, pulling data from the wrong line of the K-1 to Schedule E. Luckily, the workaround still works, too.

For the partner with the guaranteed payments, it resulted in a reduction of $3000 tax owing compared to TurboTax's previous incorrect calculation.

[beanorama]

The bug still exists. Four years running without a fix.

What's worse is that the workaround I posted years ago no longer works. Over-riding the error in the K-1 Worksheet now creates an error which is unacceptable.

TurboTax is using the wrong data. For the amount in Schedule E, Part II, Box 28(k), it is using an amount equal to self-employed earnings reported on Schedule K-1, Box 14a. It is supposed to be using the amount of income reported on Schedule K-1, Box 1.

TurboTax is wrong. Here's the authority from two current IRS instructions proving TurboTax is using the wrong data:

•  "Report box 1 income (loss) from partnership trade or business activities in which you materially participated on Schedule E (Form 1040), line 28, column (i) or (k)." 2023 Partner's Instructions for Schedule K-1, p 15
• "For nonpassive income or loss ... enter in the applicable column of line 28 your current year ordinary income or loss (after applying any special rules that limit losses) from the partner-ship ... ." 2023 Instructions for Sched E, p E-11.

For one partner TurboTax's error makes a $3290 difference in increased tax liability.

I will be calling TurboTax support for them to find a way to get our filing correct without generating an error.

[PatriciaV]

We are unable to reproduce the result you are experiencing. For Form 1040 Schedule E, the amount on Line 28 column (k) is the same as the amount on Schedule K-1 Section C column (j). The amount is taken from Section A Line 9 column (c) and does NOT include the amount reported for Self-Employment earnings (Line 14 any code). We have confirmed the flow-through is accurate according to the IRS instructions you have quoted.

If you have reviewed you current year return and are still observing this issue, you may provide us with your TurboTax ".tax2023" file to test this issue further. Note that you may not receive a response from our investigation before the filing deadline.

If you would be willing to send us a “diagnostic” file that has your “numbers” but not your personal information, please follow these instructions: 

In TurboTax Desktop, open your return and go to Online in the TurboTax header. (On a Mac computer, choose File >> Share.)

1. Choose Send Tax File to Agent.
2. You will see a message explaining what the diagnostic copy is.  Click Send on this screen and wait for the Token number to appear. 
3. Reply to this thread with your Token number and tag (@) the Expert requesting the token from you. 
4. Please include any States that are part of your return. 

We will then be able to see the same experience you are having. If we are able to determine the cause, we'll reply here and provide you with a resolution. 

[beanorama]

@PatriciaVThank you for the response. I'm pleased to see this situation has garnered some attention.

I've sent the diagnostic copy. Token #1245859. No states are included in this return -- federal only.

You have said that, in your testing, the numbers pass correctly through the Schedule K-1 form, from Section A to Section C.  TTH&B does not provide me with the specific line or box of the "data source" of the amount it reports on Schedule E Line 28(k), only saying it comes from "Sch K-1 Wks ... nonpassive income." I can't know how that form works or how the data flows through those sections and TTH&B isn't telling me the source of any of its data. 

So instead I'm just following the numbers.

You will see in my diagnostic file that there are two K-1s, the one with the error is report on Schedule E, Line 28(k), on Line B.

The amount showing there is equal to the amount of net earnings from self-employment, Schedule K-1, Part III, Line 14, Code A. It is not reporting the amount of K-1 Line 1 income as it should, but instead it is reporting the higher net earnings from self-employment, which is the larger amount, and which is wrong.

In your testing you said your number for Schedule C column (j) is taken from (equal to) that on Section A column (c). You will see in my diagnostic file that those two sections are not equal. They are showing different amounts. The amount showing on my Section C, column (j) and labeled as "Income K-1" is showing the higher amount equal to earnings from self-employment (Line 14a). Conversely, the amount showing on my Section A column (c) is showing the lesser amount equal to business income (Line 1).

This is apparently the point where your test experience is diverging from my file. You refer to the amounts in Section A passing through to Section C in your testing. In my file, Section A and C are reporting two different amounts.

If you are not able to find a cause, please respond here so I can follow-up with a support representative on the phone.

[PatriciaV]

We have confirmed the reporting on Schedule E page 2 as you described. However, this is not a program defect.

Per IRS Instructions for Form 1065 Sch K-1 Box 4a. Guaranteed Payments for Services: 

     "Guaranteed payments are payments made by a partnership to a partner that are determined without regard to the partnership's income. Generally, amounts on this line aren't passive income, and you should report them on Schedule E (Form 1040), line 28, column (k) (for example, guaranteed payments for personal services)."

Further, per IRS Instructions for Schedule E Line 28:

     "For nonpassive income or loss and passive income or losses for which you are not filing Form 8582, enter in the applicable column of line 28 your current year ordinary income or loss (after applying any special rules that limit losses) from the partnership or S corporation. Report each related item required to be reported on Schedule E (including items of income or loss stated separately on Schedule K-1) in the applicable column of a separate line following the line on which you reported the current year ordinary income or loss. Also, enter a description of the related item (for example, depletion) in column (a) of the same line."

Therefore, the amount on Schedule E Part II Line 28 should be the total of ordinary income AND guaranteed payments. We agree that the guaranteed payments should be reported on separate line and that suggestion will be forwarded to our development team to be considered for a future update.