Owners of Partnerships are taxed as self-employed individuals based on their Partnership ownership percentage. Like with an S-Corporation, partners receive a Schedule K-1 reflecting their pro rata share of the Partnership net income. However, Partnership
income is subject to self-employment tax whereas S-Corporation income is taxed only as ordinary income. Distributions on Partnership K-1s are reflected on Line 19 and marked with an “A”.
Limited Liability Companies (LLCs)
Owners of Limited Liability Companies are known as members. LLCs that have two or more members report taxes on IRS Form 1065, which is the same form used for Partnerships. The state of California has a separate form for Limited Liability Companies,
which is Form 568. Members of LLCs receive Schedule K-1s for their proportionate share of the LLC’s net income.
Individual Income Tax Returns
Individual income tax returns (IRS Form 1040/Franchise Tax Board Form 540) contain the road map for the various sources of income and tax deductions utilized in preparation of support calculations. Although they are presumptively correct per In re Marriage of Loh (2001) 93 Cal.App.4th 325, 112 Cal.Rptr.2d 893, caution should be exercised in placing entire reliance on what is reported on tax returns since taxpayers are generally adverse to paying taxes. It is possible that not all income has been reported on the tax returns as well as deductions for unsupported expenses or personal expenses that have been categorized as business expenses.
Wages and salaries from the business entities previously discussed are reported on Line 7. Taxable interest income is reported on Line 8A and non-taxable interest income (primarily from municipal bonds) is found on Line 8B. It is important to note that with the exception of some tax payers who are subject to alternative minimum tax (AMT), the amounts found on Line 8B are generally non-taxable and should be input into the non-taxable income box of the support calculation software.
Dividends are found on Line 9A on the individual income tax return. If the combined income and dividend income exceeds $1,500, the detail of the sources of interest and dividends can generally be found on Schedule B attached to the tax return. Rental income and expenses are found on Schedule E, page 1 of the individual income tax return.
The net rental income may require adjustments such as the adding back of the non-cash expense depreciation and/or the reduction of the cash flow for principal paid on the mortgage loan, if any.
Schedule E, page 2, reflects the taxable income that is passed through from the business entities (S-Corporation, Partnership, LLCs) as discussed earlier. Note this is the taxable income only, and does not necessarily correlate with the distributions.
Tax deductions known as itemized deductions are found on Schedule A. Since most support calculation software utilizes gross income and then calculates the taxes, it is important that material tax deductions be included when utilizing such software. The two most common tax deductions are real estate taxes found on Line 6 of Schedule A, and mortgage interest, found on Lines 10 and 11 of the Schedule A. Other potentially relevant deductions are medical expenses found on Line 4, recurring charitable contributions listed on Line 18, and unreimbursed business expenses and other miscellaneous itemized deductions noted on Line 26.
Self-employed individuals who are owners of sole proprietorships report the income, expenses and net profit from their businesses on Schedule C attached to the individual income tax return. In cases of self-employed individuals, the Schedule C should be examined carefully for expenses that are personal in nature (i.e. perquisites) as adjustments to income may be required in order to reflect the owner’s true ability to pay support.