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Amending Taxes

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Amending Taxes

Amending taxes Publication 541 - Main Content Table of Contents Forming a PartnershipOrganizations Classified as Partnerships Family Partnership Partnership Agreement Terminating a PartnershipIRS e-file (Electronic Filing) Exclusion From Partnership Rules Partnership Return (Form 1065) Partnership DistributionsSubstantially appreciated inventory items. Amending taxes Partner's Gain or Loss Partner's Basis for Distributed Property Transactions Between Partnership and PartnersGuaranteed Payments Sale or Exchange of Property Contribution of Property Contribution of Services Basis of Partner's InterestAdjusted Basis Effect of Partnership Liabilities Disposition of Partner's InterestSale, Exchange, or Other Transfer Payments for Unrealized Receivables and Inventory Items Liquidation at Partner's Retirement or Death Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA)Partnership Item. Amending taxes Small Partnerships and the Small Partnership Exception Small Partnership TEFRA Election Role of Tax Matters Partner (TMP) in TEFRA Proceedings Statute of Limitations and TEFRA Amended Returns and Administrative Adjustment Requests (AARs) How To Get Tax Help Forming a Partnership The following sections contain general information about partnerships. Amending taxes Organizations Classified as Partnerships An unincorporated organization with two or more members is generally classified as a partnership for federal tax purposes if its members carry on a trade, business, financial operation, or venture and divide its profits. Amending taxes However, a joint undertaking merely to share expenses is not a partnership. Amending taxes For example, co-ownership of property maintained and rented or leased is not a partnership unless the co-owners provide services to the tenants. Amending taxes The rules you must use to determine whether an organization is classified as a partnership changed for organizations formed after 1996. Amending taxes Organizations formed after 1996. Amending taxes   An organization formed after 1996 is classified as a partnership for federal tax purposes if it has two or more members and it is none of the following. Amending taxes An organization formed under a federal or state law that refers to it as incorporated or as a corporation, body corporate, or body politic. Amending taxes An organization formed under a state law that refers to it as a joint-stock company or joint-stock association. Amending taxes An insurance company. Amending taxes Certain banks. Amending taxes An organization wholly owned by a state, local, or foreign government. Amending taxes An organization specifically required to be taxed as a corporation by the Internal Revenue Code (for example, certain publicly traded partnerships). Amending taxes Certain foreign organizations identified in section 301. Amending taxes 7701-2(b)(8) of the regulations. Amending taxes A tax-exempt organization. Amending taxes A real estate investment trust. Amending taxes An organization classified as a trust under section 301. Amending taxes 7701-4 of the regulations or otherwise subject to special treatment under the Internal Revenue Code. Amending taxes Any other organization that elects to be classified as a corporation by filing Form 8832. Amending taxes For more information, see the instructions for Form 8832. Amending taxes Limited liability company. Amending taxes   A limited liability company (LLC) is an entity formed under state law by filing articles of organization as an LLC. Amending taxes Unlike a partnership, none of the members of an LLC are personally liable for its debts. Amending taxes An LLC may be classified for federal income tax purposes as either a partnership, a corporation, or an entity disregarded as an entity separate from its owner by applying the rules in Regulations section 301. Amending taxes 7701-3. Amending taxes See Form 8832 and section 301. Amending taxes 7701-3 of the regulations for more details. Amending taxes A domestic LLC with at least two members that does not file Form 8832 is classified as a partnership for federal income tax purposes. Amending taxes Organizations formed before 1997. Amending taxes   An organization formed before 1997 and classified as a partnership under the old rules will generally continue to be classified as a partnership as long as the organization has at least two members and does not elect to be classified as a corporation by filing Form 8832. Amending taxes Community property. Amending taxes    Spouses who own a qualified entity (defined later) can choose to classify the entity as a partnership for federal tax purposes by filing the appropriate partnership tax returns. Amending taxes They can choose to classify the entity as a sole proprietorship by filing a Schedule C (Form 1040) listing one spouse as the sole proprietor. Amending taxes A change in reporting position will be treated for federal tax purposes as a conversion of the entity. Amending taxes   A qualified entity is a business entity that meets all the following requirements. Amending taxes The business entity is wholly owned by spouses as community property under the laws of a state, a foreign country, or a possession of the United States. Amending taxes No person other than one or both spouses would be considered an owner for federal tax purposes. Amending taxes The business entity is not treated as a corporation. Amending taxes   For more information about community property, see Publication 555, Community Property. Amending taxes Publication 555 discusses the community property laws of Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, and Wisconsin. Amending taxes Family Partnership Members of a family can be partners. Amending taxes However, family members (or any other person) will be recognized as partners only if one of the following requirements is met. Amending taxes If capital is a material income-producing factor, they acquired their capital interest in a bona fide transaction (even if by gift or purchase from another family member), actually own the partnership interest, and actually control the interest. Amending taxes If capital is not a material income-producing factor, they joined together in good faith to conduct a business. Amending taxes They agreed that contributions of each entitle them to a share in the profits, and some capital or service has been (or is) provided by each partner. Amending taxes Capital is material. Amending taxes   Capital is a material income-producing factor if a substantial part of the gross income of the business comes from the use of capital. Amending taxes Capital is ordinarily an income-producing factor if the operation of the business requires substantial inventories or investments in plants, machinery, or equipment. Amending taxes Capital is not material. Amending taxes   In general, capital is not a material income-producing factor if the income of the business consists principally of fees, commissions, or other compensation for personal services performed by members or employees of the partnership. Amending taxes Capital interest. Amending taxes   A capital interest in a partnership is an interest in its assets that is distributable to the owner of the interest in either of the following situations. Amending taxes The owner withdraws from the partnership. Amending taxes The partnership liquidates. Amending taxes   The mere right to share in earnings and profits is not a capital interest in the partnership. Amending taxes Gift of capital interest. Amending taxes   If a family member (or any other person) receives a gift of a capital interest in a partnership in which capital is a material income-producing factor, the donee's distributive share of partnership income is subject to both of the following restrictions. Amending taxes It must be figured by reducing the partnership income by reasonable compensation for services the donor renders to the partnership. Amending taxes The donee's distributive share of partnership income attributable to donated capital must not be proportionately greater than the donor's distributive share attributable to the donor's capital. Amending taxes Purchase. Amending taxes   For purposes of determining a partner's distributive share, an interest purchased by one family member from another family member is considered a gift from the seller. Amending taxes The fair market value of the purchased interest is considered donated capital. Amending taxes For this purpose, members of a family include only spouses, ancestors, and lineal descendants (or a trust for the primary benefit of those persons). Amending taxes Example. Amending taxes A father sold 50% of his business to his son. Amending taxes The resulting partnership had a profit of $60,000. Amending taxes Capital is a material income-producing factor. Amending taxes The father performed services worth $24,000, which is reasonable compensation, and the son performed no services. Amending taxes The $24,000 must be allocated to the father as compensation. Amending taxes Of the remaining $36,000 of profit due to capital, at least 50%, or $18,000, must be allocated to the father since he owns a 50% capital interest. Amending taxes The son's share of partnership profit cannot be more than $18,000. Amending taxes Business owned and operated by spouses. Amending taxes   If spouses carry on a business together and share in the profits and losses, they may be partners whether or not they have a formal partnership agreement. Amending taxes If so, they should report income or loss from the business on Form 1065. Amending taxes They should not report the income on a Schedule C (Form 1040) in the name of one spouse as a sole proprietor. Amending taxes However, the spouses can elect not to treat the joint venture as a partnership by making a Qualified Joint Venture Election. Amending taxes Qualified Joint Venture Election. Amending taxes   A "qualified joint venture," whose only members are spouses filing a joint return, can elect not to be treated as a partnership for federal tax purposes. Amending taxes A qualified joint venture conducts a trade or business where: the only members of the joint venture are spouses filing jointly; both spouses elect not to be treated as a partnership; both spouses materially participate in the trade or business (see Passive Activity Limitations in the Instructions for Form 1065 for a definition of material participation); and the business is co-owned by both spouses and is not held in the name of a state law entity such as a partnership or LLC. Amending taxes   Under this election, a qualified joint venture conducted by spouses who file a joint return is not treated as a partnership for federal tax purposes and therefore does not have a Form 1065 filing requirement. Amending taxes All items of income, gain, deduction, loss, and credit are divided between the spouses based on their respective interests in the venture. Amending taxes Each spouse takes into account his or her respective share of these items as a sole proprietor. Amending taxes Each spouse would account for his or her respective share on the appropriate form, such as Schedule C (Form 1040). Amending taxes For purposes of determining net earnings from self-employment, each spouse's share of income or loss from a qualified joint venture is taken into account just as it is for federal income tax purposes (i. Amending taxes e. Amending taxes , based on their respective interests in the venture). Amending taxes   If the spouses do not make the election to treat their respective interests in the joint venture as sole proprietorships, each spouse should carry his or her share of the partnership income or loss from Schedule K-1 (Form 1065) to their joint or separate Form(s) 1040. Amending taxes Each spouse should include his or her respective share of self-employment income on a separate Schedule SE (Form 1040), Self-Employment Tax. Amending taxes   This generally does not increase the total tax on the return, but it does give each spouse credit for social security earnings on which retirement benefits are based. Amending taxes However, this may not be true if either spouse exceeds the social security tax limitation. Amending taxes   For more information on qualified joint ventures, go to IRS. Amending taxes gov, enter “Election for Qualified Joint Ventures” in the search box and select the link reading “Election for Husband and Wife Unincorporated Businesses. Amending taxes ” Partnership Agreement The partnership agreement includes the original agreement and any modifications. Amending taxes The modifications must be agreed to by all partners or adopted in any other manner provided by the partnership agreement. Amending taxes The agreement or modifications can be oral or written. Amending taxes Partners can modify the partnership agreement for a particular tax year after the close of the year but not later than the date for filing the partnership return for that year. Amending taxes This filing date does not include any extension of time. Amending taxes If the partnership agreement or any modification is silent on any matter, the provisions of local law are treated as part of the agreement. Amending taxes Terminating a Partnership A partnership terminates when one of the following events takes place. Amending taxes All its operations are discontinued and no part of any business, financial operation, or venture is continued by any of its partners in a partnership. Amending taxes At least 50% of the total interest in partnership capital and profits is sold or exchanged within a 12-month period, including a sale or exchange to another partner. Amending taxes Unlike other partnerships, an electing large partnership does not terminate on the sale or exchange of 50% or more of the partnership interests within a 12-month period. Amending taxes See section 1. Amending taxes 708-1(b) of the regulations for more information on the termination of a partnership. Amending taxes For special rules that apply to a merger, consolidation, or division of a partnership, see sections 1. Amending taxes 708-1(c) and 1. Amending taxes 708-1(d) of the regulations. Amending taxes Date of termination. Amending taxes   The partnership's tax year ends on the date of termination. Amending taxes For the event described in (1), above, the date of termination is the date the partnership completes the winding up of its affairs. Amending taxes For the event described in (2), above, the date of termination is the date of the sale or exchange of a partnership interest that, by itself or together with other sales or exchanges in the preceding 12 months, transfers an interest of 50% or more in both capital and profits. Amending taxes Short period return. Amending taxes   If a partnership is terminated before the end of what would otherwise be its tax year, Form 1065 must be filed for the short period, which is the period from the beginning of the tax year through the date of termination. Amending taxes The return is due the 15th day of the fourth month following the date of termination. Amending taxes See Partnership Return (Form 1065), later, for information about filing Form 1065. Amending taxes Conversion of partnership into limited liability company (LLC). Amending taxes   The conversion of a partnership into an LLC classified as a partnership for federal tax purposes does not terminate the partnership. Amending taxes The conversion is not a sale, exchange, or liquidation of any partnership interest; the partnership's tax year does not close; and the LLC can continue to use the partnership's taxpayer identification number. Amending taxes   However, the conversion may change some of the partners' bases in their partnership interests if the partnership has recourse liabilities that become nonrecourse liabilities. Amending taxes Because the partners share recourse and nonrecourse liabilities differently, their bases must be adjusted to reflect the new sharing ratios. Amending taxes If a decrease in a partner's share of liabilities exceeds the partner's basis, he or she must recognize gain on the excess. Amending taxes For more information, see Effect of Partnership Liabilities under Basis of Partner's Interest, later. Amending taxes   The same rules apply if an LLC classified as a partnership is converted into a partnership. Amending taxes IRS e-file (Electronic Filing) Please click here for the text description of the image. Amending taxes e-file Certain partnerships with more than 100 partners are required to file Form 1065, Schedules K-1, and related forms and schedules electronically (e-file). Amending taxes Other partnerships generally have the option to file electronically. Amending taxes For details about IRS e-file, see the Form 1065 instructions. Amending taxes Exclusion From Partnership Rules Certain partnerships that do not actively conduct a business can choose to be completely or partially excluded from being treated as partnerships for federal income tax purposes. Amending taxes All the partners must agree to make the choice, and the partners must be able to compute their own taxable income without computing the partnership's income. Amending taxes However, the partners are not exempt from the rule that limits a partner's distributive share of partnership loss to the adjusted basis of the partner's partnership interest. Amending taxes Nor are they exempt from the requirement of a business purpose for adopting a tax year for the partnership that differs from its required tax year. Amending taxes Investing partnership. Amending taxes   An investing partnership can be excluded if the participants in the joint purchase, retention, sale, or exchange of investment property meet all the following requirements. Amending taxes They own the property as co-owners. Amending taxes They reserve the right separately to take or dispose of their shares of any property acquired or retained. Amending taxes They do not actively conduct business or irrevocably authorize some person acting in a representative capacity to purchase, sell, or exchange the investment property. Amending taxes Each separate participant can delegate authority to purchase, sell, or exchange his or her share of the investment property for the time being for his or her account, but not for a period of more than a year. Amending taxes Operating agreement partnership. Amending taxes   An operating agreement partnership group can be excluded if the participants in the joint production, extraction, or use of property meet all the following requirements. Amending taxes They own the property as co-owners, either in fee or under lease or other form of contract granting exclusive operating rights. Amending taxes They reserve the right separately to take in kind or dispose of their shares of any property produced, extracted, or used. Amending taxes They do not jointly sell services or the property produced or extracted. Amending taxes Each separate participant can delegate authority to sell his or her share of the property produced or extracted for the time being for his or her account, but not for a period of time in excess of the minimum needs of the industry, and in no event for more than one year. Amending taxes However, this exclusion does not apply to an unincorporated organization one of whose principal purposes is cycling, manufacturing, or processing for persons who are not members of the organization. Amending taxes Electing the exclusion. Amending taxes   An eligible organization that wishes to be excluded from the partnership rules must make the election not later than the time for filing the partnership return for the first tax year for which exclusion is desired. Amending taxes This filing date includes any extension of time. Amending taxes See Regulations section 1. Amending taxes 761-2(b) for the procedures to follow. Amending taxes Partnership Return (Form 1065) Every partnership that engages in a trade or business or has gross income must file an information return on Form 1065 showing its income, deductions, and other required information. Amending taxes The partnership return must show the names and addresses of each partner and each partner's distributive share of taxable income. Amending taxes The return must be signed by a general partner. Amending taxes If a limited liability company is treated as a partnership, it must file Form 1065 and one of its members must sign the return. Amending taxes A partnership is not considered to engage in a trade or business, and is not required to file a Form 1065, for any tax year in which it neither receives income nor pays or incurs any expenses treated as deductions or credits for federal income tax purposes. Amending taxes See the Instructions for Form 1065 for more information about who must file Form 1065. Amending taxes Partnership Distributions Partnership distributions include the following. Amending taxes A withdrawal by a partner in anticipation of the current year's earnings. Amending taxes A distribution of the current year's or prior years' earnings not needed for working capital. Amending taxes A complete or partial liquidation of a partner's interest. Amending taxes A distribution to all partners in a complete liquidation of the partnership. Amending taxes A partnership distribution is not taken into account in determining the partner's distributive share of partnership income or loss. Amending taxes If any gain or loss from the distribution is recognized by the partner, it must be reported on his or her return for the tax year in which the distribution is received. Amending taxes Money or property withdrawn by a partner in anticipation of the current year's earnings is treated as a distribution received on the last day of the partnership's tax year. Amending taxes Effect on partner's basis. Amending taxes   A partner's adjusted basis in his or her partnership interest is decreased (but not below zero) by the money and adjusted basis of property distributed to the partner. Amending taxes See Adjusted Basis under Basis of Partner's Interest, later. Amending taxes Effect on partnership. Amending taxes   A partnership generally does not recognize any gain or loss because of distributions it makes to partners. Amending taxes The partnership may be able to elect to adjust the basis of its undistributed property. Amending taxes Certain distributions treated as a sale or exchange. Amending taxes   When a partnership distributes the following items, the distribution may be treated as a sale or exchange of property rather than a distribution. Amending taxes Unrealized receivables or substantially appreciated inventory items distributed in exchange for any part of the partner's interest in other partnership property, including money. Amending taxes Other property (including money) distributed in exchange for any part of a partner's interest in unrealized receivables or substantially appreciated inventory items. Amending taxes   See Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. Amending taxes   This treatment does not apply to the following distributions. Amending taxes A distribution of property to the partner who contributed the property to the partnership. Amending taxes Payments made to a retiring partner or successor in interest of a deceased partner that are the partner's distributive share of partnership income or guaranteed payments. Amending taxes Substantially appreciated inventory items. Amending taxes   Inventory items of the partnership are considered to have appreciated substantially in value if, at the time of the distribution, their total fair market value is more than 120% of the partnership's adjusted basis for the property. Amending taxes However, if a principal purpose for acquiring inventory property is to avoid ordinary income treatment by reducing the appreciation to less than 120%, that property is excluded. Amending taxes Partner's Gain or Loss A partner generally recognizes gain on a partnership distribution only to the extent any money (and marketable securities treated as money) included in the distribution exceeds the adjusted basis of the partner's interest in the partnership. Amending taxes Any gain recognized is generally treated as capital gain from the sale of the partnership interest on the date of the distribution. Amending taxes If partnership property (other than marketable securities treated as money) is distributed to a partner, he or she generally does not recognize any gain until the sale or other disposition of the property. Amending taxes For exceptions to these rules, see Distribution of partner's debt and Net precontribution gain, later. Amending taxes Also, see Payments for Unrealized Receivables and Inventory Items under Disposition of Partner's Interest, later. Amending taxes Example. Amending taxes The adjusted basis of Jo's partnership interest is $14,000. Amending taxes She receives a distribution of $8,000 cash and land that has an adjusted basis of $2,000 and a fair market value of $3,000. Amending taxes Because the cash received does not exceed the basis of her partnership interest, Jo does not recognize any gain on the distribution. Amending taxes Any gain on the land will be recognized when she sells or otherwise disposes of it. Amending taxes The distribution decreases the adjusted basis of Jo's partnership interest to $4,000 [$14,000 − ($8,000 + $2,000)]. Amending taxes Marketable securities treated as money. Amending taxes   Generally, a marketable security distributed to a partner is treated as money in determining whether gain is recognized on the distribution. Amending taxes This treatment, however, does not generally apply if that partner contributed the security to the partnership or an investment partnership made the distribution to an eligible partner. Amending taxes   The amount treated as money is the security's fair market value when distributed, reduced (but not below zero) by the excess (if any) of: The partner's distributive share of the gain that would be recognized had the partnership sold all its marketable securities at their fair market value immediately before the transaction resulting in the distribution, over The partner's distributive share of the gain that would be recognized had the partnership sold all such securities it still held after the distribution at the fair market value in (1). Amending taxes   For more information, including the definition of marketable securities, see section 731(c) of the Internal Revenue Code. Amending taxes Loss on distribution. Amending taxes   A partner does not recognize loss on a partnership distribution unless all the following requirements are met. Amending taxes The adjusted basis of the partner's interest in the partnership exceeds the distribution. Amending taxes The partner's entire interest in the partnership is liquidated. Amending taxes The distribution is in money, unrealized receivables, or inventory items. Amending taxes   There are exceptions to these general rules. Amending taxes See the following discussions. Amending taxes Also, see Liquidation at Partner's Retirement or Death under Disposition of Partner's Interest, later. Amending taxes Distribution of partner's debt. Amending taxes   If a partnership acquires a partner's debt and extinguishes the debt by distributing it to the partner, the partner will recognize capital gain or loss to the extent the fair market value of the debt differs from the basis of the debt (determined under the rules discussed in Partner's Basis for Distributed Property, later). Amending taxes   The partner is treated as having satisfied the debt for its fair market value. Amending taxes If the issue price (adjusted for any premium or discount) of the debt exceeds its fair market value when distributed, the partner may have to include the excess amount in income as canceled debt. Amending taxes   Similarly, a deduction may be available to a corporate partner if the fair market value of the debt at the time of distribution exceeds its adjusted issue price. Amending taxes Net precontribution gain. Amending taxes   A partner generally must recognize gain on the distribution of property (other than money) if the partner contributed appreciated property to the partnership during the 7-year period before the distribution. Amending taxes   The gain recognized is the lesser of the following amounts. Amending taxes The excess of: The fair market value of the property received in the distribution, over The adjusted basis of the partner's interest in the partnership immediately before the distribution, reduced (but not below zero) by any money received in the distribution. Amending taxes The “net precontribution gain” of the partner. Amending taxes This is the net gain the partner would recognize if all the property contributed by the partner within 7 years of the distribution, and held by the partnership immediately before the distribution, were distributed to another partner, other than a partner who owns more than 50% of the partnership. Amending taxes For information about the distribution of contributed property to another partner, see Contribution of Property , under Transactions Between Partnership and Partners, later. Amending taxes   The character of the gain is determined by reference to the character of the net precontribution gain. Amending taxes This gain is in addition to any gain the partner must recognize if the money distributed is more than his or her basis in the partnership. Amending taxes For these rules, the term “money” includes marketable securities treated as money, as discussed earlier. Amending taxes Effect on basis. Amending taxes   The adjusted basis of the partner's interest in the partnership is increased by any net precontribution gain recognized by the partner. Amending taxes Other than for purposes of determining the gain, the increase is treated as occurring immediately before the distribution. Amending taxes See Basis of Partner's Interest , later. Amending taxes   The partnership must adjust its basis in any property the partner contributed within 7 years of the distribution to reflect any gain that partner recognizes under this rule. Amending taxes Exceptions. Amending taxes   Any part of a distribution that is property the partner previously contributed to the partnership is not taken into account in determining the amount of the excess distribution or the partner's net precontribution gain. Amending taxes For this purpose, the partner's previously contributed property does not include a contributed interest in an entity to the extent its value is due to property contributed to the entity after the interest was contributed to the partnership. Amending taxes   Recognition of gain under this rule also does not apply to a distribution of unrealized receivables or substantially appreciated inventory items if the distribution is treated as a sale or exchange, as discussed earlier. Amending taxes Partner's Basis for Distributed Property Unless there is a complete liquidation of a partner's interest, the basis of property (other than money) distributed to the partner by a partnership is its adjusted basis to the partnership immediately before the distribution. Amending taxes However, the basis of the property to the partner cannot be more than the adjusted basis of his or her interest in the partnership reduced by any money received in the same transaction. Amending taxes Example 1. Amending taxes The adjusted basis of Emily's partnership interest is $30,000. Amending taxes She receives a distribution of property that has an adjusted basis of $20,000 to the partnership and $4,000 in cash. Amending taxes Her basis for the property is $20,000. Amending taxes Example 2. Amending taxes The adjusted basis of Steve's partnership interest is $10,000. Amending taxes He receives a distribution of $4,000 cash and property that has an adjusted basis to the partnership of $8,000. Amending taxes His basis for the distributed property is limited to $6,000 ($10,000 − $4,000, the cash he receives). Amending taxes Complete liquidation of partner's interest. Amending taxes   The basis of property received in complete liquidation of a partner's interest is the adjusted basis of the partner's interest in the partnership reduced by any money distributed to the partner in the same transaction. Amending taxes Partner's holding period. Amending taxes   A partner's holding period for property distributed to the partner includes the period the property was held by the partnership. Amending taxes If the property was contributed to the partnership by a partner, then the period it was held by that partner is also included. Amending taxes Basis divided among properties. Amending taxes   If the basis of property received is the adjusted basis of the partner's interest in the partnership (reduced by money received in the same transaction), it must be divided among the properties distributed to the partner. Amending taxes For property distributed after August 5, 1997, allocate the basis using the following rules. Amending taxes Allocate the basis first to unrealized receivables and inventory items included in the distribution by assigning a basis to each item equal to the partnership's adjusted basis in the item immediately before the distribution. Amending taxes If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. Amending taxes Allocate any remaining basis to properties other than unrealized receivables and inventory items by assigning a basis to each property equal to the partnership's adjusted basis in the property immediately before the distribution. Amending taxes If the allocable basis exceeds the total of these assigned bases, increase the assigned bases by the amount of the excess. Amending taxes If the total of these assigned bases exceeds the allocable basis, decrease the assigned bases by the amount of the excess. Amending taxes Allocating a basis increase. Amending taxes   Allocate any basis increase required in rule (2), above, first to properties with unrealized appreciation to the extent of the unrealized appreciation. Amending taxes If the basis increase is less than the total unrealized appreciation, allocate it among those properties in proportion to their respective amounts of unrealized appreciation. Amending taxes Allocate any remaining basis increase among all the properties in proportion to their respective fair market values. Amending taxes Example. Amending taxes Eun's basis in her partnership interest is $55,000. Amending taxes In a distribution in liquidation of her entire interest, she receives properties A and B, neither of which is inventory or unrealized receivables. Amending taxes Property A has an adjusted basis to the partnership of $5,000 and a fair market value of $40,000. Amending taxes Property B has an adjusted basis to the partnership of $10,000 and a fair market value of $10,000. Amending taxes To figure her basis in each property, Eun first assigns bases of $5,000 to property A and $10,000 to property B (their adjusted bases to the partnership). Amending taxes This leaves a $40,000 basis increase (the $55,000 allocable basis minus the $15,000 total of the assigned bases). Amending taxes She first allocates $35,000 to property A (its unrealized appreciation). Amending taxes The remaining $5,000 is allocated between the properties based on their fair market values. Amending taxes $4,000 ($40,000/$50,000) is allocated to property A and $1,000 ($10,000/$50,000) is allocated to property B. Amending taxes Eun's basis in property A is $44,000 ($5,000 + $35,000 + $4,000) and her basis in property B is $11,000 ($10,000 + $1,000). Amending taxes Allocating a basis decrease. Amending taxes   Use the following rules to allocate any basis decrease required in rule (1) or rule (2), earlier. Amending taxes Allocate the basis decrease first to items with unrealized depreciation to the extent of the unrealized depreciation. Amending taxes If the basis decrease is less than the total unrealized depreciation, allocate it among those items in proportion to their respective amounts of unrealized depreciation. Amending taxes Allocate any remaining basis decrease among all the items in proportion to their respective assigned basis amounts (as decreased in (1)). Amending taxes Example. Amending taxes Armando's basis in his partnership interest is $20,000. Amending taxes In a distribution in liquidation of his entire interest, he receives properties C and D, neither of which is inventory or unrealized receivables. Amending taxes Property C has an adjusted basis to the partnership of $15,000 and a fair market value of $15,000. Amending taxes Property D has an adjusted basis to the partnership of $15,000 and a fair market value of $5,000. Amending taxes To figure his basis in each property, Armando first assigns bases of $15,000 to property C and $15,000 to property D (their adjusted bases to the partnership). Amending taxes This leaves a $10,000 basis decrease (the $30,000 total of the assigned bases minus the $20,000 allocable basis). Amending taxes He allocates the entire $10,000 to property D (its unrealized depreciation). Amending taxes Armando's basis in property C is $15,000 and his basis in property D is $5,000 ($15,000 − $10,000). Amending taxes Distributions before August 6, 1997. Amending taxes   For property distributed before August 6, 1997, allocate the basis using the following rules. Amending taxes Allocate the basis first to unrealized receivables and inventory items included in the distribution to the extent of the partnership's adjusted basis in those items. Amending taxes If the partnership's adjusted basis in those items exceeded the allocable basis, allocate the basis among the items in proportion to their adjusted bases to the partnership. Amending taxes Allocate any remaining basis to other distributed properties in proportion to their adjusted bases to the partnership. Amending taxes Partner's interest more than partnership basis. Amending taxes   If the basis of a partner's interest to be divided in a complete liquidation of the partner's interest is more than the partnership's adjusted basis for the unrealized receivables and inventory items distributed, and if no other property is distributed to which the partner can apply the remaining basis, the partner has a capital loss to the extent of the remaining basis of the partnership interest. Amending taxes Special adjustment to basis. Amending taxes   A partner who acquired any part of his or her partnership interest in a sale or exchange or upon the death of another partner may be able to choose a special basis adjustment for property distributed by the partnership. Amending taxes To choose the special adjustment, the partner must have received the distribution within 2 years after acquiring the partnership interest. Amending taxes Also, the partnership must not have chosen the optional adjustment to basis when the partner acquired the partnership interest. Amending taxes   If a partner chooses this special basis adjustment, the partner's basis for the property distributed is the same as it would have been if the partnership had chosen the optional adjustment to basis. Amending taxes However, this assigned basis is not reduced by any depletion or depreciation that would have been allowed or allowable if the partnership had previously chosen the optional adjustment. Amending taxes   The choice must be made with the partner's tax return for the year of the distribution if the distribution includes any property subject to depreciation, depletion, or amortization. Amending taxes If the choice does not have to be made for the distribution year, it must be made with the return for the first year in which the basis of the distributed property is pertinent in determining the partner's income tax. Amending taxes   A partner choosing this special basis adjustment must attach a statement to his or her tax return that the partner chooses under section 732(d) of the Internal Revenue Code to adjust the basis of property received in a distribution. Amending taxes The statement must show the computation of the special basis adjustment for the property distributed and list the properties to which the adjustment has been allocated. Amending taxes Example. Amending taxes Chin Ho purchased a 25% interest in X partnership for $17,000 cash. Amending taxes At the time of the purchase, the partnership owned inventory having a basis to the partnership of $14,000 and a fair market value of $16,000. Amending taxes Thus, $4,000 of the $17,000 he paid was attributable to his share of inventory with a basis to the partnership of $3,500. Amending taxes Within 2 years after acquiring his interest, Chin Ho withdrew from the partnership and for his entire interest received cash of $1,500, inventory with a basis to the partnership of $3,500, and other property with a basis of $6,000. Amending taxes The value of the inventory received was 25% of the value of all partnership inventory. Amending taxes (It is immaterial whether the inventory he received was on hand when he acquired his interest. Amending taxes ) Since the partnership from which Chin Ho withdrew did not make the optional adjustment to basis, he chose to adjust the basis of the inventory received. Amending taxes His share of the partnership's basis for the inventory is increased by $500 (25% of the $2,000 difference between the $16,000 fair market value of the inventory and its $14,000 basis to the partnership at the time he acquired his interest). Amending taxes The adjustment applies only for purposes of determining his new basis in the inventory, and not for purposes of partnership gain or loss on disposition. Amending taxes The total to be allocated among the properties Chin Ho received in the distribution is $15,500 ($17,000 basis of his interest − $1,500 cash received). Amending taxes His basis in the inventory items is $4,000 ($3,500 partnership basis + $500 special adjustment). Amending taxes The remaining $11,500 is allocated to his new basis for the other property he received. Amending taxes Mandatory adjustment. Amending taxes   A partner does not always have a choice of making this special adjustment to basis. Amending taxes The special adjustment to basis must be made for a distribution of property (whether or not within 2 years after the partnership interest was acquired) if all the following conditions existed when the partner received the partnership interest. Amending taxes The fair market value of all partnership property (other than money) was more than 110% of its adjusted basis to the partnership. Amending taxes If there had been a liquidation of the partner's interest immediately after it was acquired, an allocation of the basis of that interest under the general rules (discussed earlier under Basis divided among properties) would have decreased the basis of property that could not be depreciated, depleted, or amortized and increased the basis of property that could be. Amending taxes The optional basis adjustment, if it had been chosen by the partnership, would have changed the partner's basis for the property actually distributed. Amending taxes Required statement. Amending taxes   Generally, if a partner chooses a special basis adjustment and notifies the partnership, or if the partnership makes a distribution for which the special basis adjustment is mandatory, the partnership must provide a statement to the partner. Amending taxes The statement must provide information necessary for the partner to compute the special basis adjustment. Amending taxes Marketable securities. Amending taxes   A partner's basis in marketable securities received in a partnership distribution, as determined in the preceding discussions, is increased by any gain recognized by treating the securities as money. Amending taxes See Marketable securities treated as money under Partner's Gain or Loss, earlier. Amending taxes The basis increase is allocated among the securities in proportion to their respective amounts of unrealized appreciation before the basis increase. Amending taxes Transactions Between Partnership and Partners For certain transactions between a partner and his or her partnership, the partner is treated as not being a member of the partnership. Amending taxes These transactions include the following. Amending taxes Performing services for, or transferring property to, a partnership if: There is a related allocation and distribution to a partner, and The entire transaction, when viewed together, is properly characterized as occurring between the partnership and a partner not acting in the capacity of a partner. Amending taxes Transferring money or other property to a partnership if: There is a related transfer of money or other property by the partnership to the contributing partner or another partner, and The transfers together are properly characterized as a sale or exchange of property. Amending taxes Payments by accrual basis partnership to cash basis partner. Amending taxes   A partnership that uses an accrual method of accounting cannot deduct any business expense owed to a cash basis partner until the amount is paid. Amending taxes However, this rule does not apply to guaranteed payments made to a partner, which are generally deductible when accrued. Amending taxes Guaranteed Payments Guaranteed payments are those made by a partnership to a partner that are determined without regard to the partnership's income. Amending taxes A partnership treats guaranteed payments for services, or for the use of capital, as if they were made to a person who is not a partner. Amending taxes This treatment is for purposes of determining gross income and deductible business expenses only. Amending taxes For other tax purposes, guaranteed payments are treated as a partner's distributive share of ordinary income. Amending taxes Guaranteed payments are not subject to income tax withholding. Amending taxes The partnership generally deducts guaranteed payments on line 10 of Form 1065 as a business expense. Amending taxes They are also listed on Schedules K and K-1 of the partnership return. Amending taxes The individual partner reports guaranteed payments on Schedule E (Form 1040) as ordinary income, along with his or her distributive share of the partnership's other ordinary income. Amending taxes Guaranteed payments made to partners for organizing the partnership or syndicating interests in the partnership are capital expenses. Amending taxes Generally, organizational and syndication expenses are not deductible by the partnership. Amending taxes However, a partnership can elect to deduct a portion of its organizational expenses and amortize the remaining expenses (see Business start-up and organizational costs in the Instructions for Form 1065). Amending taxes Organizational expenses (if the election is not made) and syndication expenses paid to partners must be reported on the partners' Schedule K-1 as guaranteed payments. Amending taxes Minimum payment. Amending taxes   If a partner is to receive a minimum payment from the partnership, the guaranteed payment is the amount by which the minimum payment is more than the partner's distributive share of the partnership income before taking into account the guaranteed payment. Amending taxes Example. Amending taxes Under a partnership agreement, Divya is to receive 30% of the partnership income, but not less than $8,000. Amending taxes The partnership has net income of $20,000. Amending taxes Divya's share, without regard to the minimum guarantee, is $6,000 (30% × $20,000). Amending taxes The guaranteed payment that can be deducted by the partnership is $2,000 ($8,000 − $6,000). Amending taxes Divya's income from the partnership is $8,000, and the remaining $12,000 of partnership income will be reported by the other partners in proportion to their shares under the partnership agreement. Amending taxes If the partnership net income had been $30,000, there would have been no guaranteed payment since her share, without regard to the guarantee, would have been greater than the guarantee. Amending taxes Self-employed health insurance premiums. Amending taxes   Premiums for health insurance paid by a partnership on behalf of a partner, for services as a partner, are treated as guaranteed payments. Amending taxes The partnership can deduct the payments as a business expense, and the partner must include them in gross income. Amending taxes However, if the partnership accounts for insurance paid for a partner as a reduction in distributions to the partner, the partnership cannot deduct the premiums. Amending taxes   A partner who qualifies can deduct 100% of the health insurance premiums paid by the partnership on his or her behalf as an adjustment to income. Amending taxes The partner cannot deduct the premiums for any calendar month, or part of a month, in which the partner is eligible to participate in any subsidized health plan maintained by any employer of the partner, the partner's spouse, the partner's dependents, or any children under age 27 who are not dependents. Amending taxes For more information on the self-employed health insurance deduction, see chapter 6 in Publication 535. Amending taxes Including payments in partner's income. Amending taxes   Guaranteed payments are included in income in the partner's tax year in which the partnership's tax year ends. Amending taxes Example 1. Amending taxes Under the terms of a partnership agreement, Erica is entitled to a fixed annual payment of $10,000 without regard to the income of the partnership. Amending taxes Her distributive share of the partnership income is 10%. Amending taxes The partnership has $50,000 of ordinary income after deducting the guaranteed payment. Amending taxes She must include ordinary income of $15,000 ($10,000 guaranteed payment + $5,000 ($50,000 × 10%) distributive share) on her individual income tax return for her tax year in which the partnership's tax year ends. Amending taxes Example 2. Amending taxes Lamont is a calendar year taxpayer who is a partner in a partnership. Amending taxes The partnership uses a fiscal year that ended January 31, 2013. Amending taxes Lamont received guaranteed payments from the partnership from February 1, 2012, until December 31, 2012. Amending taxes He must include these guaranteed payments in income for 2013 and report them on his 2013 income tax return. Amending taxes Payments resulting in loss. Amending taxes   If guaranteed payments to a partner result in a partnership loss in which the partner shares, the partner must report the full amount of the guaranteed payments as ordinary income. Amending taxes The partner separately takes into account his or her distributive share of the partnership loss, to the extent of the adjusted basis of the partner's partnership interest. Amending taxes Sale or Exchange of Property Special rules apply to a sale or exchange of property between a partnership and certain persons. Amending taxes Losses. Amending taxes   Losses will not be allowed from a sale or exchange of property (other than an interest in the partnership) directly or indirectly between a partnership and a person whose direct or indirect interest in the capital or profits of the partnership is more than 50%. Amending taxes   If the sale or exchange is between two partnerships in which the same persons directly or indirectly own more than 50% of the capital or profits interests in each partnership, no deduction of a loss is allowed. Amending taxes   The basis of each partner's interest in the partnership is decreased (but not below zero) by the partner's share of the disallowed loss. Amending taxes   If the purchaser later sells the property, only the gain realized that is greater than the loss not allowed will be taxable. Amending taxes If any gain from the sale of the property is not recognized because of this rule, the basis of each partner's interest in the partnership is increased by the partner's share of that gain. Amending taxes Gains. Amending taxes   Gains are treated as ordinary income in a sale or exchange of property directly or indirectly between a person and a partnership, or between two partnerships, if both of the following tests are met. Amending taxes More than 50% of the capital or profits interest in the partnership(s) is directly or indirectly owned by the same person(s). Amending taxes The property in the hands of the transferee immediately after the transfer is not a capital asset. Amending taxes Property that is not a capital asset includes accounts receivable, inventory, stock-in-trade, and depreciable or real property used in a trade or business. Amending taxes More than 50% ownership. Amending taxes   To determine if there is more than 50% ownership in partnership capital or profits, the following rules apply. Amending taxes An interest directly or indirectly owned by, or for, a corporation, partnership, estate, or trust is considered to be owned proportionately by, or for, its shareholders, partners, or beneficiaries. Amending taxes An individual is considered to own the interest directly or indirectly owned by, or for, the individual's family. Amending taxes For this rule, “family” includes only brothers, sisters, half-brothers, half-sisters, spouses, ancestors, and lineal descendants. Amending taxes If a person is considered to own an interest using rule (1), that person (the “constructive owner”) is treated as if actually owning that interest when rules (1) and (2) are applied. Amending taxes However, if a person is considered to own an interest using rule (2), that person is not treated as actually owning that interest in reapplying rule (2) to make another person the constructive owner. Amending taxes Example. Amending taxes Individuals A and B and Trust T are equal partners in Partnership ABT. Amending taxes A's husband, AH, is the sole beneficiary of Trust T. Amending taxes Trust T's partnership interest will be attributed to AH only for the purpose of further attributing the interest to A. Amending taxes As a result, A is a more-than-50% partner. Amending taxes This means that any deduction for losses on transactions between her and ABT will not be allowed, and gain from property that in the hands of the transferee is not a capital asset is treated as ordinary, rather than capital, gain. Amending taxes More information. Amending taxes   For more information on these special rules, see Sales and Exchanges Between Related Persons in chapter 2 of Publication 544. Amending taxes Contribution of Property Usually, neither the partner nor the partnership recognizes a gain or loss when property is contributed to the partnership in exchange for a partnership interest. Amending taxes This applies whether a partnership is being formed or is already operating. Amending taxes The partnership's holding period for the property includes the partner's holding period. Amending taxes The contribution of limited partnership interests in one partnership for limited partnership interests in another partnership qualifies as a tax-free contribution of property to the second partnership if the transaction is made for business purposes. Amending taxes The exchange is not subject to the rules explained later under Disposition of Partner's Interest. Amending taxes Disguised sales. Amending taxes   A contribution of money or other property to the partnership followed by a distribution of different property from the partnership to the partner is treated not as a contribution and distribution, but as a sale of property, if both of the following tests are met. Amending taxes The distribution would not have been made but for the contribution. Amending taxes The partner's right to the distribution does not depend on the success of partnership operations. Amending taxes   All facts and circumstances are considered in determining if the contribution and distribution are more properly characterized as a sale. Amending taxes However, if the contribution and distribution occur within 2 years of each other, the transfers are presumed to be a sale unless the facts clearly indicate that the transfers are not a sale. Amending taxes If the contribution and distribution occur more than 2 years apart, the transfers are presumed not to be a sale unless the facts clearly indicate that the transfers are a sale. Amending taxes Form 8275 required. Amending taxes   A partner must attach Form 8275, Disclosure Statement, (or other statement) to his or her return if the partner contributes property to a partnership and, within 2 years (before or after the contribution), the partnership transfers money or other consideration to the partner. Amending taxes For exceptions to this requirement, see section 1. Amending taxes 707-3(c)(2) of the regulations. Amending taxes   A partnership must attach Form 8275 (or other statement) to its return if it distributes property to a partner, and, within 2 years (before or after the distribution), the partner transfers money or other consideration to the partnership. Amending taxes   Form 8275 must include the following information. Amending taxes A caption identifying the statement as a disclosure under section 707 of the Internal Revenue Code. Amending taxes A description of the transferred property or money, including its value. Amending taxes A description of any relevant facts in determining if the transfers are properly viewed as a disguised sale. Amending taxes See section 1. Amending taxes 707-3(b)(2) of the regulations for a description of the facts and circumstances considered in determining if the transfers are a disguised sale. Amending taxes Contribution to partnership treated as investment company. Amending taxes   Gain is recognized when property is contributed (in exchange for an interest in the partnership) to a partnership that would be treated as an investment company if it were incorporated. Amending taxes   A partnership is generally treated as an investment company if over 80% of the value of its assets is held for investment and consists of certain readily marketable items. Amending taxes These items include money, stocks and other equity interests in a corporation, and interests in regulated investment companies and real estate investment trusts. Amending taxes For more information, see section 351(e)(1) of the Internal Revenue Code and the related regulations. Amending taxes Whether a partnership is treated as an investment company under this test is ordinarily determined immediately after the transfer of property. Amending taxes   This rule applies to limited partnerships and general partnerships, regardless of whether they are privately formed or publicly syndicated. Amending taxes Contribution to foreign partnership. Amending taxes   A domestic partnership that contributed property after August 5, 1997, to a foreign partnership in exchange for a partnership interest may have to file Form 8865 if either of the following apply. Amending taxes Immediately after the contribution, the partnership owned, directly or indirectly, at least a 10% interest in the foreign partnership. Amending taxes The fair market value of the property contributed to the foreign partnership, when added to other contributions of property made to the partnership during the preceding 12-month period, is greater than $100,000. Amending taxes   The partnership may also have to file Form 8865, even if no contributions are made during the tax year, if it owns a 10% or more interest in a foreign partnership at any time during the year. Amending taxes See the form instructions for more information. Amending taxes Basis of contributed property. Amending taxes   If a partner contributes property to a partnership, the partnership's basis for determining depreciation, depletion, gain, or loss for the property is the same as the partner's adjusted basis for the property when it was contributed, increased by any gain recognized by the partner at the time of contribution. Amending taxes Allocations to account for built-in gain or loss. Amending taxes   The fair market value of property at the time it is contributed may be different from the partner's adjusted basis. Amending taxes The partnership must allocate among the partners any income, deduction, gain, or loss on the property in a manner that will account for the difference. Amending taxes This rule also applies to contributions of accounts payable and other accrued but unpaid items of a cash basis partner. Amending taxes   The partnership can use different allocation methods for different items of contributed property. Amending taxes A single reasonable method must be consistently applied to each item, and the overall method or combination of methods must be reasonable. Amending taxes See section 1. Amending taxes 704-3 of the regulations for allocation methods generally considered reasonable. Amending taxes   If the partnership sells contributed property and recognizes gain or loss, built-in gain or loss is allocated to the contributing partner. Amending taxes If contributed property is subject to depreciation or other cost recovery, the allocation of deductions for these items takes into account built-in gain or loss on the property. Amending taxes However, the total depreciation, depletion, gain, or loss allocated to partners cannot be more than the depreciation or depletion allowable to the partnership or the gain or loss realized by the partnership. Amending taxes Example. Amending taxes Areta and Sofia formed an equal partnership. Amending taxes Areta contributed $10,000 in cash to the partnership and Sofia contributed depreciable property with a fair market value of $10,000 and an adjusted basis of $4,000. Amending taxes The partnership's basis for depreciation is limited to the adjusted basis of the property in Sofia's hands, $4,000. Amending taxes In effect, Areta purchased an undivided one-half interest in the depreciable property with her contribution of $10,000. Amending taxes Assuming that the depreciation rate is 10% a year under the General Depreciation System (GDS), she would have been entitled to a depreciation deduction of $500 per year, based on her interest in the partnership, if the adjusted basis of the property equaled its fair market value when contributed. Amending taxes To simplify this example, the depreciation deductions are determined without regard to any first-year depreciation conventions. Amending taxes However, since the partnership is allowed only $400 per year of depreciation (10% of $4,000), no more than $400 can be allocated between the partners. Amending taxes The entire $400 must be allocated to Areta. Amending taxes Distribution of contributed property to another partner. Amending taxes   If a partner contributes property to a partnership and the partnership distributes the property to another partner within 7 years of the contribution, the contributing partner must recognize gain or loss on the distribution. Amending taxes   The recognized gain or loss is the amount the contributing partner would have recognized if the property had been sold for its fair market value when it was distributed. Amending taxes This amount is the difference between the property's basis and its fair market value at the time of contribution. Amending taxes The character of the gain or loss will be the same as the character of the gain or loss that would have resulted if the partnership had sold the property to the distributee partner. Amending taxes Appropriate adjustments must be made to the adjusted basis of the contributing partner's partnership interest and to the adjusted basis of the property distributed to reflect the recognized gain or loss. Amending taxes Disposition of certain contributed property. Amending taxes   The following rules determine the character of the partnership's gain or loss on a disposition of certain types of contributed property. Amending taxes Unrealized receivables. Amending taxes If the property was an unrealized receivable in the hands of the contributing partner, any gain or loss on its disposition by the partnership is ordinary income or loss. Amending taxes Unrealized receivables are defined later under Payments for Unrealized Receivables and Inventory Items. Amending taxes When reading the definition, substitute “partner” for “partnership. Amending taxes ” Inventory items. Amending taxes If the property was an inventory item in the hands of the contributing partner, any gain or loss on its disposition by the partnership within 5 years after the contribution is ordinary income or loss. Amending taxes Inventory items are defined later in Payments for Unrealized Receivables and Inventory Items. Amending taxes Capital loss property. Amending taxes If the property was a capital asset in the contributing partner's hands, any loss on its disposition by the partnership within 5 years after the contribution is a capital loss. Amending taxes The capital loss is limited to the amount by which the partner's adjusted basis for the property exceeded the property's fair market value immediately before the contribution. Amending taxes Substituted basis property. Amending taxes If the disposition of any of the property listed in (1), (2), or (3) is a nonrecognition transaction, these rules apply when the recipient of the property disposes of any substituted basis property (other than certain corporate stock) resulting from the transaction. Amending taxes Contribution of Services A partner can acquire an interest in partnership capital or profits as compensation for services performed or to be performed. Amending taxes Capital interest. Amending taxes   A capital interest is an interest that would give the holder a share of the proceeds if the partnership's assets were sold at fair market value and the proceeds were distributed in a complete liquidation of the partnership. Amending taxes This determination generally is made at the time of receipt of the partnership interest. Amending taxes The fair market value of such an interest received by a partner as compensation for services must generally be included in the partner's gross income in the first tax year in which the partner can transfer the interest or the interest is not subject to a substantial risk of forfeiture. Amending taxes The capital interest transferred as compensation for services is subject to the rules for restricted property discussed in Publication 525 under Employee Compensation. Amending taxes   The fair market value of an interest in partnership capital transferred to a partner as payment for services to the partnership is a guaranteed payment, discussed earlier. Amending taxes Profits interest. Amending taxes   A profits interest is a partnership interest other than a capital interest. Amending taxes If a person receives a profits interest for providing services to, or for the benefit of, a partnership in a partner capacity or in anticipation of being a partner, the receipt of such an interest is not a taxable event for the partner or the partnership. Amending taxes However, this does not apply in the following situations. Amending taxes The profits interest relates to a substantially certain and predictable stream of income from partnership assets, such as income from high-quality debt securities or a high-quality net lease. Amending taxes Within 2 years of receipt, the partner disposes of the profits interest. Amending taxes The profits interest is a limited partnership interest in a publicly traded partnership. Amending taxes   A profits interest transferred as compensation for services is not subject to the rules for restricted property that apply to capital interests. Amending taxes Basis of Partner's Interest The basis of a partnership interest is the money plus the adjusted basis of any property the partner contributed. Amending taxes If the partner must recognize gain as a result of the contribution, this gain is included in the basis of his or her interest. Amending taxes Any increase in a partner's individual liabilities because of an assumption of partnership liabilities is considered a contribution of money to the partnership by the partner. Amending taxes Interest acquired by gift, etc. Amending taxes   If a partner acquires an interest in a partnership by gift, inheritance, or under any circumstance other than by a contribution of money or property to the partnership, the partner's basis must be determined using the basis rules described in Publication 551. Amending taxes Adjusted Basis There is a worksheet for adjusting the basis of a partner's interest in the partnership in the Partner's Instructions for Schedule K-1 (Form 1065). Amending taxes The basis of an interest in a partnership is increased or decreased by certain items. Amending taxes Increases. Amending taxes   A partner's basis is increased by the following items. Amending taxes The partner's additional contributions to the partnership, including an increased share of, or assumption of, partnership liabilities. Amending taxes The partner's distributive share of taxable and nontaxable partnership income. Amending taxes The partner's distributive share of the excess of the deductions for depletion over the basis of the depletable property, unless the property is oil or gas wells whose basis has been allocated to partners. Amending taxes Decreases. Amending taxes   The partner's basis is decreased (but never below zero) by the following items. Amending taxes The money (including a decreased share of partnership liabilities or an assumption of the partner's individual liabilities by the partnership) and adjusted basis of property distributed to the partner by the partnership. Amending taxes The partner's distributive share of the partnership losses (including capital losses). Amending taxes The partner's distributive share of nondeductible partnership expenses that are not capital expenditures. Amending taxes This includes the partner's share of any section 179 expenses, even if the partner cannot deduct the entire amount on his or her individual income tax return. Amending taxes The partner's deduction for depletion for any partnership oil and gas wells, up to the proportionate share of the adjusted basis of the wells allocated to the partner. Amending taxes Partner's liabilities assumed by partnership. Amending taxes   If contributed property is subject to a debt or if a partner's liabilities are assumed by the partnership, the basis of that partner's interest is reduced (but not below zero) by the liability assumed by the other partners. Amending taxes This partner must reduce his or her basis because the assumption of the liability is treated as a distribution of money to that partner. Amending taxes The other partners' assumption of the liability is treated as a contribution by them of money to the partnership. Amending taxes See Effect of Partnership Liabilities , later. Amending taxes Example 1. Amending taxes Ivan acquired a 20% interest in a partnership by contributing property that had an adjusted basis to him of $8,000 and a $4,000 mortgage. Amending taxes The partnership assumed payment of the mortgage. Amending taxes The basis of Ivan's interest is: Adjusted basis of contributed property $8,000 Minus: Part of mortgage assumed by other partners (80% × $4,000) 3,200 Basis of Ivan's partnership interest $4,800 Example 2. Amending taxes If, in Example 1, the contributed property had a $12,000 mortgage, the basis of Ivan's partnership interest would be zero. Amending taxes The $1,600 difference between the mortgage assumed by the other partners, $9,600 (80% × $12,000), and his basis of $8,000 would be treated as capital gain from the sale or exchange of a partnership interest. Amending taxes However, this gain would not increase the basis of his partnership interest. Amending taxes Book value of partner's interest. Amending taxes   The adjusted basis of a partner's interest is determined without considering any amount shown in the partnership books as a capital, equity, or similar account. Amending taxes Example. Amending taxes Enzo contributes to his partnership property that has an adjusted basis of $400 and a fair market value of $1,000. Amending taxes His partner contributes $1,000 cash. Amending taxes While each partner has increased his capital account by $1,000, which will be re
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Understanding your CP21B Notice

We made the change(s) you requested to your tax return for the tax year specified on the notice. You should receive your refund within 2-3 weeks of your notice.

Printable samples of this notice (PDF)

Tax publications you may find useful

How to get help

Calling the toll free number listed on the top right corner of your notice is the fastest way to get your questions answered.

You can also authorize someone (such as an accountant) to contact the IRS on your behalf using this Power of Attorney and Declaration of Representative (Form 2848).

Or you may qualify for help from a Low Income Taxpayer Clinic.
 


What you need to do

  • Read your notice carefully ― it shows the area(s) of your tax return that changed, e.g., Schedule A.
  • If you agree with the notice, you don't need to do anything.
  • Contact us if you disagree with the change(s) we made.
  • Correct the copy of your tax return that you kept for your records.
  • Be sure to report any interest we paid you on your tax return for this year.

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Answers to Common Questions

What if I don't receive my refund in 2-3 weeks?
If you don't owe other taxes or debts we're required to collect, such as child support, and 3 weeks have lapsed, call us at the toll-free number listed on the top right corner of your notice.

Will I receive information about the interest that I need to report on my next tax return?
If you were paid $10 or more in interest, you'll receive a Form 1099-INT from IRS by January 31st of next year. Please note, even if the interest amount paid to you is less than $10, you must report this amount on your tax return.

The notice says "We made the changes you requested to your 2006 Form 1040 to adjust your..." but I don't remember sending any change to IRS. How can I find out what IRS received to initiate this change?
Please contact us at the number listed on the top right corner of your notice for specific information about your tax return.

What if I need to make another correction to my account?
You'll need to file Form 1040X, Amended U.S. Individual Income Tax Return.

What if I have tried to get answers and after contacting IRS several times have not been successful?
Call Taxpayer Advocate at 1-877-777-4778 or for TTY/TDD 1-800-829-4059.

What if I think I’m a victim of identity theft?
Please contact us at the number listed on the top right corner of your notice. Refer to the IRS Identity Theft resource page for more information.


Tips for next year

Consider filing your taxes electronically. Filing online can help you avoid mistakes and find credits and deductions that you may qualify for. In many cases you can file for free. Learn more about e-file.

Page Last Reviewed or Updated: 26-Feb-2014

The Amending Taxes

Amending taxes 10. Amending taxes   Self-Employment (SE) Tax Table of Contents Who Must Pay SE Tax?Special Rules and Exceptions Figuring Earnings Subject to SE Tax Farm Optional Method Using Both Optional Methods Reporting Self-Employment Tax The SE tax rules apply no matter how old you are and even if you are already receiving social security and Medicare benefits. Amending taxes Who Must Pay SE Tax? Generally, you must pay SE tax and file Schedule SE (Form 1040) if your net earnings from self-employment were $400 or more. Amending taxes Use Schedule SE to figure net earnings from self-employment. Amending taxes Sole proprietor or independent contractor. Amending taxes   If you are self-employed as a sole proprietor or independent contractor, you generally use Schedule C or C-EZ (Form 1040) to figure your earnings subject to SE tax. Amending taxes SE tax rate. Amending taxes    For 2013, the SE tax rate on net earnings is 15. Amending taxes 3% (12. Amending taxes 4% social security tax plus 2. Amending taxes 9% Medicare tax). Amending taxes Maximum earnings subject to self-employment tax. Amending taxes    Only the first $113,700 of your combined wages, tips, and net earnings in 2013 is subject to any combination of the 12. Amending taxes 4% social security part of SE tax, social security tax, or railroad retirement (tier 1) tax. Amending taxes   All of your combined wages, tips, and net earnings in 2013 are subject to any combination of the 2. Amending taxes 9% Medicare part of SE tax, social security tax, or railroad retirement (tier 1) tax. Amending taxes   If your wages and tips are subject to either social security or railroad retirement (tier 1) tax, or both, and total at least $113,700, do not pay the 12. Amending taxes 4% social security part of the SE tax on any of your net earnings. Amending taxes However, you must pay the 2. Amending taxes 9% Medicare part of the SE tax on all your net earnings. Amending taxes Special Rules and Exceptions Aliens. Amending taxes   Generally, resident aliens must pay self-employment tax under the same rules that apply to U. Amending taxes S. Amending taxes citizens. Amending taxes Nonresident aliens are not subject to SE tax unless an international social security agreement in effect determines that they are covered under the U. Amending taxes S. Amending taxes social security system. Amending taxes However, residents of the Virgin Islands, Puerto Rico, Guam, the Commonwealth of the Northern Mariana Islands, or American Samoa are subject to self-employment tax, as they are considered U. Amending taxes S. Amending taxes residents for self-employment tax purposes. Amending taxes For more information on aliens, see Publication 519, U. Amending taxes S. Amending taxes Tax Guide for Aliens. Amending taxes Child employed by parent. Amending taxes   You are not subject to SE tax if you are under age 18 and you are working for your father or mother. Amending taxes Church employee. Amending taxes    If you work for a church or a qualified church-controlled organization (other than as a minister or member of a religious order) that elected an exemption from social security and Medicare taxes, you are subject to SE tax if you receive $108. Amending taxes 28 or more in wages from the church or organization. Amending taxes For more information, see Publication 517, Social Security and Other Information for Members of the Clergy and Religious Workers. Amending taxes Fishing crew member. Amending taxes   If you are a member of the crew on a boat that catches fish or other water life, your earnings are subject to SE tax if all the following conditions apply. Amending taxes You do not get any pay for the work except your share of the catch or a share of the proceeds from the sale of the catch, unless the pay meets all the following conditions. Amending taxes The pay is not more than $100 per trip. Amending taxes The pay is received only if there is a minimum catch. Amending taxes The pay is solely for additional duties (such as mate, engineer, or cook) for which additional cash pay is traditional in the fishing industry. Amending taxes You get a share of the catch or a share of the proceeds from the sale of the catch. Amending taxes Your share depends on the amount of the catch. Amending taxes The boat's operating crew normally numbers fewer than 10 individuals. Amending taxes (An operating crew is considered as normally made up of fewer than 10 if the average size of the crew on trips made during the last four calendar quarters is fewer than 10. Amending taxes ) Notary public. Amending taxes   Fees you receive for services you perform as a notary public are reported on Schedule C or C-EZ but are not subject to self-employment tax (see the Instructions for Schedule SE (Form 1040)). Amending taxes State or local government employee. Amending taxes   You are subject to SE tax if you are an employee of a state or local government, are paid solely on a fee basis, and your services are not covered under a federal-state social security agreement. Amending taxes Foreign government or international organization employee. Amending taxes   You are subject to SE tax if both the following conditions are true. Amending taxes You are a U. Amending taxes S. Amending taxes citizen employed in the United States, Puerto Rico, Guam, American Samoa, the Commonwealth of the Northern Mariana Islands, or the Virgin Islands by: A foreign government, A wholly-owned agency of a foreign government, or An international organization. Amending taxes Your employer is not required to withhold social security and Medicare taxes from your wages. Amending taxes U. Amending taxes S. Amending taxes citizen or resident alien residing abroad. Amending taxes    If you are a self-employed U. Amending taxes S. Amending taxes citizen or resident alien living outside the United States, in most cases you must pay SE tax. Amending taxes Do not reduce your foreign earnings from self-employment by your foreign earned income exclusion. Amending taxes Exception. Amending taxes    The United States has social security agreements with many countries to eliminate double taxation under two social security systems. Amending taxes Under these agreements, you generally must only pay social security and Medicare taxes to the country in which you live. Amending taxes The country to which you must pay the tax will issue a certificate which serves as proof of exemption from social security tax in the other country. Amending taxes   For more information, see the Instructions for Schedule SE (Form 1040). Amending taxes More Than One Business If you have earnings subject to SE tax from more than one trade, business, or profession, you must combine the net profit (or loss) from each to determine your total earnings subject to SE tax. Amending taxes A loss from one business reduces your profit from another business. Amending taxes Community Property Income If any of the income from a trade or business, other than a partnership, is community property income under state law, it is included in the earnings subject to SE tax of the spouse carrying on the trade or business. Amending taxes Gain or Loss Do not include in earnings subject to SE tax a gain or loss from the disposition of property that is neither stock in trade nor held primarily for sale to customers. Amending taxes It does not matter whether the disposition is a sale, exchange, or an involuntary conversion. Amending taxes Lost Income Payments If you are self-employed and reduce or stop your business activities, any payment you receive from insurance or other sources for the lost business income is included in earnings subject to SE tax. Amending taxes If you are not working when you receive the payment, it still relates to your business and is included in earnings subject to SE tax, even though your business is temporarily inactive. Amending taxes Figuring Earnings Subject to SE Tax Methods for Figuring Net Earnings There are three ways to figure your net earnings from self-employment. Amending taxes The regular method. Amending taxes The nonfarm optional method. Amending taxes The farm optional method. Amending taxes You must use the regular method unless you are eligible to use one or both of the optional methods. Amending taxes Why use an optional method?    You may want to use the optional methods (discussed later) when you have a loss or a small net profit and any one of the following applies. Amending taxes You want to receive credit for social security benefit coverage. Amending taxes You incurred child or dependent care expenses for which you could claim a credit. Amending taxes (An optional method may increase your earned income, which could increase your credit. Amending taxes ) You are entitled to the earned income credit. Amending taxes (An optional method may increase your earned income, which could increase your credit. Amending taxes ) You are entitled to the additional child tax credit. Amending taxes (An optional method may increase your earned income, which could increase your credit. Amending taxes ) Effects of using an optional method. Amending taxes   Using an optional method could increase your SE tax. Amending taxes Paying more SE tax could result in your getting higher benefits when you retire. Amending taxes   If you use either or both optional methods, you must figure and pay the SE tax due under these methods even if you would have had a smaller tax or no tax using the regular method. Amending taxes   The optional methods may be used only to figure your SE tax. Amending taxes To figure your income tax, include your actual earnings in gross income, regardless of which method you use to determine SE tax. Amending taxes Regular Method Multiply your total earnings subject to SE tax by 92. Amending taxes 35% (. Amending taxes 9235) to get your net earnings under the regular method. Amending taxes See Short Schedule SE, line 4, or Long Schedule SE, line 4a. Amending taxes Net earnings figured using the regular method are also called actual net earnings. Amending taxes Nonfarm Optional Method Use the nonfarm optional method only for earnings that do not come from farming. Amending taxes You may use this method if you meet all the following tests. Amending taxes You are self-employed on a regular basis. Amending taxes This means that your actual net earnings from self-employment were $400 or more in at least 2 of the 3 tax years before the one for which you use this method. Amending taxes The net earnings can be from either farm or nonfarm earnings or both. Amending taxes You have used this method less than 5 years. Amending taxes (There is a 5-year lifetime limit. Amending taxes ) The years do not have to be one after another. Amending taxes Your net nonfarm profits were: Less than $5,024, and Less than 72. Amending taxes 189% of your gross nonfarm income. Amending taxes Net nonfarm profits. Amending taxes   Net nonfarm profit generally is the total of the amounts from: Line 31, Schedule C (Form 1040), Line 3, Schedule C-EZ (Form 1040), Box 14, code A, Schedule K-1 (Form 1065) (from nonfarm partnerships), and Box 9, code J1, Schedule K-1 (Form 1065-B). Amending taxes   However, you may need to adjust the amount reported on Schedule K-1 if you are a general partner or if it is a loss. Amending taxes Gross nonfarm income. Amending taxes   Your gross nonfarm income generally is the total of the amounts from: Line 7, Schedule C (Form 1040), Line 1, Schedule C-EZ (Form 1040), Box 14, code C, Schedule K-1 (Form 1065) (from nonfarm partnerships), and Box 9, code J2, Schedule K-1 (Form 1065-B). Amending taxes Figuring Nonfarm Net Earnings If you meet the three tests explained earlier, use the following table to figure your net earnings from self-employment under the nonfarm optional method. Amending taxes Table 10-1. Amending taxes Figuring Nonfarm Net Earnings IF your gross nonfarm income is. Amending taxes . Amending taxes . Amending taxes THEN your net earnings are equal to. Amending taxes . Amending taxes . Amending taxes $6,960 or less Two-thirds of your gross nonfarm income. Amending taxes More than $6,960 $4,640 Actual net earnings. Amending taxes   Your actual net earnings are 92. Amending taxes 35% of your total earnings subject to SE tax (that is, multiply total earnings subject to SE tax by 92. Amending taxes 35% (. Amending taxes 9235) to get actual net earnings). Amending taxes Actual net earnings are equivalent to net earnings figured using the regular method. Amending taxes Optional net earnings less than actual net earnings. Amending taxes   You cannot use this method to report an amount less than your actual net earnings from self-employment. Amending taxes Gross nonfarm income of $6,960 or less. Amending taxes   The following examples illustrate how to figure net earnings when gross nonfarm income is $6,960 or less. Amending taxes Example 1. Amending taxes Net nonfarm profit less than $5,024 and less than 72. Amending taxes 189% of gross nonfarm income. Amending taxes Ann Green runs a craft business. Amending taxes Her actual net earnings from self-employment were $800 in 2011 and $900 in 2012. Amending taxes She meets the test for being self-employed on a regular basis. Amending taxes She has used the nonfarm optional method less than 5 years. Amending taxes Her gross income and net profit in 2013 are as follows: Gross nonfarm income $5,400 Net nonfarm profit $1,200 Ann's actual net earnings for 2013 are $1,108 ($1,200 × . Amending taxes 9235). Amending taxes Because her net profit is less than $5,024 and less than 72. Amending taxes 189% of her gross income, she can use the nonfarm optional method to figure net earnings of $3,600 (2/3 × $5,400). Amending taxes Because these net earnings are higher than her actual net earnings, she can report net earnings of $3,600 for 2013. Amending taxes Example 2. Amending taxes Net nonfarm profit less than $5,024 but not less than 72. Amending taxes 189% of gross nonfarm income. Amending taxes Assume that in Example 1 Ann's gross income is $1,000 and her net profit is $800. Amending taxes She must use the regular method to figure her net earnings. Amending taxes She cannot use the nonfarm optional method because her net profit is not less than 72. Amending taxes 189% of her gross income. Amending taxes Example 3. Amending taxes Net loss from a nonfarm business. Amending taxes Assume that in Example 1 Ann has a net loss of $700. Amending taxes She can use the nonfarm optional method and report $3,600 (2/3 × $5,400) as her net earnings. Amending taxes Example 4. Amending taxes Nonfarm net earnings less than $400. Amending taxes Assume that in Example 1 Ann has gross income of $525 and a net profit of $175. Amending taxes In this situation, she would not pay any SE tax under either the regular method or the nonfarm optional method because her net earnings under both methods are less than $400. Amending taxes Gross nonfarm income of more than $6,960. Amending taxes   The following examples illustrate how to figure net earnings when gross nonfarm income is more than $6,960. Amending taxes Example 1. Amending taxes Net nonfarm profit less than $5,024 and less than 72. Amending taxes 189% of gross nonfarm income. Amending taxes John White runs an appliance repair shop. Amending taxes His actual net earnings from self-employment were $10,500 in 2011 and $9,500 in 2012. Amending taxes He meets the test for being self-employed on a regular basis. Amending taxes He has used the nonfarm optional method less than 5 years. Amending taxes His gross income and net profit in 2013 are as follows: Gross nonfarm income $12,000 Net nonfarm profit $1,200 John's actual net earnings for 2013 are $1,108 ($1,200 × . Amending taxes 9235). Amending taxes Because his net profit is less than $5,024 and less than 72. Amending taxes 189% of his gross income, he can use the nonfarm optional method to figure net earnings of $4,640. Amending taxes Because these net earnings are higher than his actual net earnings, he can report net earnings of $4,640 for 2013. Amending taxes Example 2. Amending taxes Net nonfarm profit not less than $5,024. Amending taxes Assume that in Example 1 John's net profit is $5,400. Amending taxes He must use the regular method. Amending taxes He cannot use the nonfarm optional method because his net nonfarm profit is not less than $5,024. Amending taxes Example 3. Amending taxes Net loss from a nonfarm business. Amending taxes Assume that in Example 1 John has a net loss of $700. Amending taxes He can use the nonfarm optional method and report $4,640 as his net earnings from self-employment. Amending taxes Farm Optional Method Use the farm optional method only for earnings from a farming business. Amending taxes See Publication 225 for information about this method. Amending taxes Using Both Optional Methods If you have both farm and nonfarm earnings, you may be able to use both optional methods to determine your net earnings from self-employment. Amending taxes To figure your net earnings using both optional methods, you must: Figure your farm and nonfarm net earnings separately under each method. Amending taxes Do not combine farm earnings with nonfarm earnings to figure your net earnings under either method. Amending taxes Add the net earnings figured under each method to arrive at your total net earnings from self-employment. Amending taxes You can report less than your total actual farm and nonfarm net earnings but not less than actual nonfarm net earnings. Amending taxes If you use both optional methods, you can report no more than $4,640 as your combined net earnings from self-employment. Amending taxes Example. Amending taxes You are a self-employed farmer. Amending taxes You also operate a retail grocery store. Amending taxes Your gross income, actual net earnings from self-employment, and optional farm and optional nonfarm net earnings from self-employment are shown in Table 10-2. Amending taxes Table 10-2. Amending taxes Example—Farm and Nonfarm Earnings Income and Earnings Farm Nonfarm Gross income $3,000 $6,000 Actual net earnings $900 $500 Optional net earnings (2/3 of gross income) $2,000 $4,000 Table 10-3 shows four methods or combinations of methods you can use to figure net earnings from self-employment using the farm and nonfarm gross income and actual net earnings shown in Table 10-2. Amending taxes Method 1. Amending taxes Using the regular method for both farm and nonfarm income. Amending taxes Method 2. Amending taxes Using the optional method for farm income and the regular method for nonfarm income. Amending taxes Method 3. Amending taxes Using the regular method for farm income and the optional method for nonfarm income. Amending taxes Method 4. Amending taxes Using the optional method for both farm and nonfarm income. Amending taxes Note. Amending taxes Actual net earnings is the same as net earnings figured using the regular method. Amending taxes Table 10-3. Amending taxes Example—Net Earnings Net Earnings 1 2 3 4 Actual  farm $ 900   $ 900   Optional  farm   $ 2,000   $ 2,000 Actual nonfarm $ 500 $ 500     Optional nonfarm     $4,000 $4,000 Amount you can report: $1,400 $2,500 $4,900 $4,640* *Limited to $4,640 because you used both optional methods. Amending taxes Fiscal Year Filer If you use a tax year other than the calendar year, you must use the tax rate and maximum earnings limit in effect at the beginning of your tax year. Amending taxes Even if the tax rate or maximum earnings limit changes during your tax year, continue to use the same rate and limit throughout your tax year. Amending taxes Reporting Self-Employment Tax Use Schedule SE (Form 1040) to figure and report your SE tax. Amending taxes Then enter the SE tax on line 56 of Form 1040 and attach Schedule SE to Form 1040. Amending taxes Most taxpayers can use Section A—Short Schedule SE to figure their SE tax. Amending taxes However, certain taxpayers must use Section B—Long Schedule SE. Amending taxes If you have to pay SE tax, you must file Form 1040 (with Schedule SE attached) even if you do not otherwise have to file a federal income tax return. Amending taxes Joint return. Amending taxes   Even if you file a joint return, you cannot file a joint Schedule SE. Amending taxes This is true whether one spouse or both spouses have earnings subject to SE tax. Amending taxes If both of you have earnings subject to SE tax, each of you must complete a separate Schedule SE. Amending taxes However, if one spouse uses the Short Schedule SE and the other spouse has to use the Long Schedule SE, both can use the same form. Amending taxes Attach both schedules to the joint return. Amending taxes More than one business. Amending taxes   If you have more than one trade or business, you must combine the net profit (or loss) from each business to figure your SE tax. Amending taxes A loss from one business will reduce your profit from another business. Amending taxes File one Schedule SE showing the earnings from self-employment, but file a separate Schedule C, C-EZ, or F for each business. Amending taxes Example. Amending taxes You are the sole proprietor of two separate businesses. Amending taxes You operate a restaurant that made a net profit of $25,000. Amending taxes You also have a cabinetmaking business that had a net loss of $500. Amending taxes You must file a Schedule C for the restaurant showing your net profit of $25,000 and another Schedule C for the cabinetmaking business showing your net loss of $500. Amending taxes You file Schedule SE showing total earnings subject to SE tax of $24,500. Amending taxes Prev  Up  Next   Home   More Online Publications