REG, Regulation

Sources for Reporting Pass-Through Items: The Schedule K-1

Last reviewed 2026-09-14

The standards and authorities behind PocketCPA's REG lessons on Reporting Pass-Through Items: The Schedule K-1. The topic rests on IRC Secs. 702, 1366.

About this topic

A partnership does not pay income tax on its profit. It divides the profit among its owners, and the owners pay. Partnerships and S corporations are conduits: they generally pay no entity-level income tax and instead push their results out to the owners.

Everything on the REG exam in this area follows from one design decision. Congress had to decide how much arithmetic to do at the entity and how much to leave for the owner. It chose to do at the entity only the arithmetic whose answer cannot vary from owner to owner, and to hand out everything else item by item.

Key points

• Schedule K-1 reports each partner's or shareholder's share of income, deductions, credits, and other items.
• Pass-through items retain their character at the partner or shareholder level for purposes like capital gains and charitable deductions.
• Separately stated items are those that could affect partners differently; nonseparately stated items are aggregated.
• The partner's share of liabilities increases basis and allows additional loss deductions.

What the lessons cover

1. The flow-through model
2. Separately stated versus non-separately stated items
3. Character retention
4. Basis limitation on losses (Sec. 704(d) and Sec. 1366(d))
5. Guaranteed payments and the partner who is treated as a stranger (Sec. 707(c))
6. Self-employment tax on pass-through income (Sec. 1402(a))
7. The three loss gates, in the order they apply
8. Gate three in detail: what counts as passive income, and how suspended losses get out
9. Charitable contributions through a conduit, and the owner-level limits that meet them

Authoritative references

• IRC Sec. 701 and Sec. 1363(a): the conduit rule; partners and shareholders, not the entity, bear the income tax.
• IRC Sec. 702(a)(1) through (a)(8): the enumerated separately stated items, with the ordinary residual at Sec. 702(a)(8). Sec. 702(b): character determined as if realized directly from the entity's source. Sec. 702(c): the partner's gross income includes a share of partnership gross income.
• IRC Sec. 703(a)(1) and (a)(2)(A) through (F): entity-level computation and the six deductions denied to a partnership. Sec. 703(b)(1) through (3): elections are made by the partnership except Secs. 108(b)(5) and (c)(3), 617, and 901.
• IRC Sec. 704(a) and (b)(1), (b)(2): allocations follow the agreement unless it is silent or the allocation lacks substantial economic effect. Sec. 704(d)(1), (d)(2): the basis ceiling and its carryover. Sec. 704(d)(3)(A), (B): charitable contributions inside the ceiling, appreciation outside it. Sec. 704(e)(1), (e)(2): an interest created by gift, with the donor-compensation and proportionality exceptions to the donee's inclusion and the military-service sentence. The same paragraphs treat an intra-family purchase as created by gift, with the purchased interest's fair market value treated as donated capital. They were recaptioned and renumbered by Pub. L. 114-74 Sec. 1102(b), and applied by Sec. 1102(c) to partnership taxable years beginning after December 31, 2015.
• IRC Sec. 705(a)(1)(A) through (C) and (a)(2)(A), (B): the partner's basis account. Sec. 722: opening basis. Sec. 733(1), (2): distributions reduce it. Sec. 752(a), (b): liability shifts are deemed contributions and distributions.
• IRC Sec. 706(a): the inclusion year. Sec. 706(b)(1)(B), (b)(1)(C), (b)(3), (b)(4)(A): the permitted partnership year, and the rule that deferral is not a business purpose. Sec. 706(d)(1): the varying-interests method when a partner's interest changes. Sec. 706(d)(2)(A)(i), (A)(ii), (B)(i) through (iv), (C)(i), (C)(ii), (D)(i), (D)(ii): allocable cash basis items and the closed four-item list. These paragraphs assign the item to the days in the period to which it is attributable, and then to the interests at the close of each day. They throw pre-year and post-year portions back to the first and last days, and apply the Sec. 755 capitalization to any part allocated to a person who is no longer a partner. Sec. 706(d)(3): the parallel proration for upper tier and lower tier partnerships. Sec. 706(d)(4): the taxable year determined without regard to Sec. 706(c)(2)(A).
• IRC Sec. 707(a)(1), (a)(2) and Sec. 707(c): non-partner-capacity transactions, the disguised-payment rule as amended by Pub. L. 119-21 Sec. 70602 for services performed and property transferred after July 4, 2025, and guaranteed payments.
• IRC Sec. 1363(b)(1) through (4) and Sec. 1363(c)(1), (c)(2): the S corporation computation and its shorter election-exception list.
• IRC Sec. 1366(a)(1)(A), (a)(1)(B) and the flush sentence, Sec. 1366(a)(2), Sec. 1366(b): pass-through and character. Sec. 1366(d)(1)(A), (B), (d)(2)(A), (B), (d)(3)(A) through (D), (d)(4)(A), (B): the stock-plus-debt ceiling, indefinite carryover, the post-termination transition period, and the charitable carve-out.
• IRC Sec. 1367(a)(1)(A) through (C), (a)(2)(A) through (E) and its flush sentence, (b)(1), (b)(2)(A), (B): basis adjustments, the adjusted-basis measure for contributed property, and the stock-then-debt ordering with reversed restoration.
• IRC Sec. 1368(b)(1), (b)(2): distributions with no accumulated earnings and profits.
• IRC Sec. 1377(a)(1)(A), (B) and (a)(2)(A): per-share, per-day allocation and the election to close the year on a termination.
• IRC Sec. 1401 and IRC Sec. 1402(a) carry the self-employment computation in four parts.
  • The rates. Sec. 1401(a), Sec. 1401(b)(1) and Sec. 1401(b)(2).
  • The base. Sec. 1402(a), which reaches Sec. 702(a)(8) income and guaranteed payments.
  • The exclusions. Sec. 1402(a)(1) rentals, Sec. 1402(a)(2) dividends and interest, Sec. 1402(a)(3)(A) through (C) capital gains and losses, and Sec. 1402(a)(13) a limited partner's distributive share as such.
  • The deduction. Sec. 1402(a)(12)(A) and Sec. 1402(a)(12)(B), computed at one-half of the combined rates.
• IRC Sec. 465 is the at-risk gate. Its paragraphs divide into the limit, the account, the related-lender screen, the activity, and the recapture.
  • Sec. 465(a)(1) limits the loss to the amount at risk at the close of the year.
  • Sec. 465(a)(2) carries the disallowed excess into the first succeeding year.
  • Sec. 465(b)(1)(A) and Sec. 465(b)(1)(B) open the account with contributions and with borrowed amounts.
  • Sec. 465(b)(2)(A) and Sec. 465(b)(2)(B) count a borrowing only where the taxpayer is personally liable or has pledged outside property.
  • Sec. 465(b)(3)(A) is the related-lender screen.
  • Sec. 465(b)(3)(B)(i) and Sec. 465(b)(3)(B)(ii) protect an interest as a creditor and, where a corporation borrows from a shareholder, an interest as a shareholder.
  • Sec. 465(b)(3)(C)(i) and Sec. 465(b)(3)(C)(ii) supply the relationship tests, read at 10 percent.
  • Sec. 465(b)(4) strips out amounts protected against loss by nonrecourse financing, guarantees and stop loss agreements.
  • Sec. 465(b)(5) reduces the account by losses already allowed.
  • Sec. 465(b)(6)(A) through (E) are the real property exception for qualified nonrecourse financing.
  • Sec. 465(c)(1)(A) through (E) enumerate the five named activities.
  • Sec. 465(c)(2)(A)(i) through (v) slice each named activity into a separate activity of its own.
  • Sec. 465(c)(2)(B)(i) aggregates a partnership's or S corporation's Sec. 1245 leasing properties placed in service in one entity year.
  • Sec. 465(c)(2)(B)(ii) borrows the further aggregation rules of Sec. 465(c)(3)(B) and Sec. 465(c)(3)(C).
  • Sec. 465(c)(3)(A) is the catch-all that reaches every other trade or business and every other activity for the production of income.
  • Sec. 465(c)(3)(B) combines those catch-all activities where the taxpayer actively manages, or where 65 percent or more of the entity's losses go to active managers.
  • Sec. 465(c)(3)(C) leaves the rest of the aggregation question to regulations.
  • Sec. 465(c)(3)(D) limits Sec. 465(b)(3) to the extent regulations provide, for an activity described in Sec. 465(c)(3)(A).
  • Sec. 465(e)(1)(A) and Sec. 465(e)(1)(B) run the negative at-risk recapture into income and back out as a deduction in the succeeding year.
  • Sec. 465(e)(2)(A) and Sec. 465(e)(2)(B) cap that inclusion.
• IRC Sec. 267(b)(1) and Sec. 267(c)(4): the family relationship that Sec. 465(b)(3)(C)(i) borrows and tightens to 10 percent, which includes brothers and sisters, and which is therefore one relationship wider than the family Sec. 704(e)(2) defines for an intra-family purchase.
• Cross-references quoted from inside the operative provisions rather than verified independently here: Sec. 464(e) (farming) and Sec. 1245(a)(3) (Sec. 1245 property) appear in Sec. 465(c). So do Sec. 613(e)(2) (geothermal deposits) and Sec. 614 (oil and gas and geothermal property). Sec. 52(a) and (b) and Sec. 707(b)(1) appear in Sec. 465(b)(3)(C). Sec. 755 appears in Sec. 706(d)(2)(D)(ii), and Sec. 706(c)(2)(A) in Sec. 706(d)(4). This lesson asserts only that the operative provisions point at them, not what they say.
• IRC Sec. 469 is the passive activity gate. Its paragraphs answer four questions: what is disallowed, what counts as passive, what income can absorb a passive loss, and what releases a suspended one.
  • Sec. 469(a)(1)(A) and Sec. 469(a)(1)(B) disallow the passive activity loss and the passive activity credit, and Sec. 469(a)(2) lists the persons reached.
  • Sec. 469(b) carries a disallowed amount to the next year as a deduction allocable to the activity.
  • Sec. 469(c)(1) defines a passive activity as a trade or business in which the taxpayer does not materially participate.
  • Sec. 469(c)(2) and Sec. 469(c)(4) add any rental activity, without regard to whether the taxpayer materially participates.
  • Sec. 469(c)(3) carves out a working interest in oil or gas property held without limited liability.
  • Sec. 469(c)(7)(A) and Sec. 469(c)(7)(B) turn that rental rule off for a taxpayer meeting the real property trade or business tests.
  • Sec. 469(d)(1) measures the passive activity loss against aggregate passive income.
  • Sec. 469(d)(2)(A) and Sec. 469(d)(2)(B) measure the passive activity credit against the tax allocable to passive activities.
  • Sec. 469(e)(1)(A)(i)(I) and Sec. 469(e)(1)(B) remove portfolio income and working-capital income, and Sec. 469(e)(3) removes earned income.
  • Sec. 469(g)(1)(A) frees a suspended loss on a fully taxable disposition of the entire interest, and Sec. 469(g)(1)(B) defers that relief where the buyer is related.
  • Sec. 469(g)(2)(A) and Sec. 469(g)(2)(B) free a suspended loss at death only to the extent it exceeds the step-up.
  • Sec. 469(h)(1) sets material participation at involvement that is regular, continuous and substantial, and Sec. 469(h)(2) denies it to a limited partner.
  • Sec. 469(i)(1), Sec. 469(i)(2), Sec. 469(i)(3)(A) and Sec. 469(i)(3)(E) carry the 25,000 rental allowance and its 50 percent phase-out above 100,000 of adjusted gross income.
  • Sec. 469(i)(6)(A) requires an interest of at least 10 percent by value, and Sec. 469(i)(6)(C) refuses active participation to a limited partner.
  • Sec. 469(j)(6)(A) and Sec. 469(j)(6)(B) add a suspended loss to basis on a gift and bar it as a deduction for any taxable year.
  • Sec. 469(j)(9) lets a transferor trade an unused credit for basis immediately before the transfer.
  • Sec. 469(k)(1) through (k)(3) apply the section separately to each publicly traded partnership, and require disposal of the entire partnership interest.
• IRC Sec. 170 carries the owner-level charitable limits, as amended by Pub. L. 119-21 Secs. 70424 through 70429 for taxable years beginning after December 31, 2025.
  • Sec. 170(b)(1)(C)(i) caps capital gain property given to a public charity at 30 percent of the contribution base.
  • Sec. 170(b)(1)(H) defines the contribution base as adjusted gross income computed without regard to any net operating loss carryback.
  • Sec. 170(b)(1)(I) imposes the 0.5 percent floor on the aggregate of the contributions.
  • Sec. 170(b)(2)(A)(i) and Sec. 170(b)(2)(A)(ii) give a corporate owner the band above 1 percent and below 10 percent of taxable income.
  • Sec. 170(e)(1)(A) reduces the contribution itself by the gain that would not have been long-term capital gain on a sale at fair market value.
• IRC Sec. 179(d)(8): the Sec. 179 limits apply at the entity and again at each owner. Sec. 1211(b)(1), (b)(2): the capital loss allowance a Sec. 1231 ordinary loss escapes. Sec. 1231(a)(1), (a)(2), (a)(3), (b)(1), (c)(1), (c)(2) and Sec. 1245(a)(1), (a)(2)(A): the character components a conduit must keep separate.
• Reg. Sec. 1.704-1(d)(1) and Reg. Sec. 1.704-1(d)(4) Example 2; Reg. Sec. 1.707-1(c) with Examples 1 and 2. Also Reg. Sec. 1.1367-1(c)(2) and Reg. Sec. 1.1367-1(f), and Rev. Rul. 59-221.

How PocketCPA uses these sources

Every lesson is written in original words and cites the paragraph each rule comes from. No standard's text is reproduced. How lessons and questions are written and checked is set out in our methodology.

See also

• Sources for every REG topic
• Free REG sample questions
• The CPA exam glossary