Overriding Self Employment Taxes for Investment General Partnership

[TaxCat1]

How do I override self employment taxes for general partnership that only has investment activities?  

Partnership receives K1's with ordinary income (box 1) which triggers self employment worksheet on form 1065.

I have tried deleting self employment worksheet but it pops up again.

Cannot label partners as limited partners to avoid self employment worksheet, since they are general partners (and each time I go through partners questions, it resets to general partner status).

Tried overriding numbers in self employment worksheet, but self employment numbers still show on K1's for partners.

see here from page 41 of 1065 instructions:

"If the partnership is engaged solely in the operation of a group investment program, earnings from the operation generally aren't self-employment earnings for either general or limited partners"

[PatriciaV]

Yes, you can adjust the allocation of self-employment earnings in Forms Mode by entering an offsetting adjustment for the Self-Employment Earnings allocation.

1. Open your return and click the Forms icon in the TurboTax header.
2. In the forms list on the left, find Sch K Reconcile.
3. Click the form name to open it in the large window.
4. Click the Print button at the bottom of the form to print this, as you'll need the numbers in the third column (14A Net SE Earn/Loss) for the next step.
5. Find Sch K-1 Wks and click to open. Note that this form has an embedded slide bar on the right side. Use this to move from one partner to another.
6. In the right column, for Special Allocations >> By Amount >> Box A, enter the amount for this partner from Sch K Reconcile with the opposite number sign (enter a negative number if Sch K Reconcile is positive and vice versa).
7. Repeat for all partners. Total entries for Box A should match the total for column 14A on Sch K Reconcile.
8. Look for SE Earnings Wks and click to open.
9. On Line 4d, enter the letter A in the small box, then enter in Column A the total from Sch K Reconcile with the opposite number sign (this is the offset to Line 3c).
10. Confirm that the number in Column B Line 5 is zero.
11. Go back to Sch K-1 Reconcile and confirm that the 14a column is all zeroes. If not, you need to go back to Sch K-1 Wks and correct your entries for the special allocation amounts.
12. If you wish, you can review each Schedule K-1 to confirm that no self-employment earnings appear in Box 14 A.
13. When finished, click Step-by-Step to return to the main screens.

[TaxCat1]

@PatriciaV thanks for the explanation.

So anytime the partnership receives a K1 with ordinary income from another partnership, the self employment worksheet is generated and the partners allocated self employment on Box 14 of K1, even though the partners are not truly self employed? 

This is for an investment partnership.

Seems like TurboTax would have built something to avoid this such as question or prompt, instead of the lengthy workaround in this thread.

Am I missing something?

[PatriciaV]

General Partners who materially participate in a partnership must pay self-employment taxes on most income reported to them by the partnership, even flow-through income (the exceptions are dividends, interest, and rental income - see IRS Instructions for Form 1065 Schedule K-1 Self-Employment). This is not true for Limited Partners. The attorney who prepared the partnership documents for you should have explained this before a decision was made to make all the partners General Partners.

Since this is the general rule, TurboTax allocates income to Schedule K-1 Box 14 accordingly. Your investment group is an exception to the rule, which requires special handling.

[TaxCat1]

@PatriciaV great answer. thanks.

Does the question of material participation determine whether self employment worksheet is triggered?

Could a question be built into software that asks whether materially participating? 

I have seen a similar question in TurboTax Home and Business when adding a K-1.

instead of cumbersome workaround with overriding numbers to cancel out self employment income.

or am I misunderstanding something? Thanks for everything

[AliciaP1]

If your partnership is considered the General Partner in the investment partnership, the Ordinary income is essentially the performance fee or allocation you receive for the effort and is correctly identified as SE income to be passed to your partners.  If this is not the case, you should not be receiving a K-1 with Ordinary Business Income listed and you need to contact the investment partnership to get clarification and/or a corrected Schedule K-1.

@TaxCat1 

[TaxCat1]

@AliciaP1 

thanks for the response.

The partnership is a limited partner and receives K-1 with Box 1 income.

[DianeW777]

Limited partners don't pay self-employment tax on their distributive share of partnership income, but do pay self-employment tax on guaranteed payments.  If you do not have guaranteed payments then you should not have self employment tax.  If this is the case, then you should not have an entry in Box 14, of your K1. 

• IRS FAQ

If you do have an entry in that box, then check with the accounting office that issued the K1 to see if a correction is necessary.

[TaxCat1]

Partnership A is a investment partnership with general partners. 

Partnership A is a limited partner in a different partnership and it receives box 1 income.  

turbo tax is treating that income as ordinary income to those general partners — as well as self employment income. 

[TaxCat1]

@PatriciaV 

Thanks for the work-around suggestion. 

I tried it and it works; however, 14c (nonfarm income) is still active and flowing to K-1 as self employment income with code C.

Why does 14c get activated?  

And how to override 14c properly?  Its source is different than 14a.

[PatriciaV]

To see the data source for Line 14c, right click on the amount then choose "Data Source." TurboTax displays a formula for how this amount is calculated (it can't be overridden for an e-filed return).

Once you know the source, you can set up special allocation(s) for the income flowing to 14c as you did for the other income sources. Just use a different Special Allocation line on the Schedule K-1 Worksheet.

[TaxCat1]

@PatriciaV 

14c is sourced from Line 8 on page 1 of 1065.

Adding special allocation on K-1 worksheet did not change 14c.

[PatriciaV]

Form 1065 Line 8 is the total of Lines 3 through 7. Which line is the source of the amount on Schedule K-1 Line 4c?

You may need to add a special allocation for that line instead.

[TaxCat1]

@PatriciaV 

Schedule K-1 Line 4c  is Total guaranteed payments.

K-1 Line 14c sources from 1065 Line 14c which sources from 1065 total of lines 3-7. 

Adding special allocations is not affecting or changing any other part of the return.  Not sure what I'm missing on special allocations to make it work.

[PatriciaV]

Guaranteed payments are always subject to self-employment taxes. Did you make guaranteed payments to any of the members? If not, you need to go back and correct those entries.