Updated October 16, 2026. Quick answer: Box 18 of Schedule K-1 (Form 1065) reports tax-exempt income and nondeductible expenses in three codes. Tax-exempt interest in code A is reported on Form 1040, line 2a, as an item of information, and it increases the partner’s basis. Nondeductible expenses in code C reduce basis and are not deducted.
What box 18 reports
On the form, line 18 of Part III reads “Tax-exempt income and nondeductible expenses”. There are three codes, and each has a stated effect on the partner’s adjusted basis in the partnership. The other boxes are on the Schedule K-1 (Form 1065) boxes overview. The three effects are explained below.
| Code | Item | Effect on basis, as printed |
|---|---|---|
| A | Tax-exempt interest income | “Increase the adjusted basis of your interest in the partnership by this amount.” |
| B | Other tax-exempt income | “Increase the adjusted basis of your interest in the partnership by the amount shown, but don’t include it in income on your tax return.” |
| C | Nondeductible expenses | “Decrease the adjusted basis of your interest in the partnership by this amount.” |
Code A, tax-exempt interest
The instructions give a reporting step even though the income is not taxed. “Report on your return, as an item of information, your share of the tax-exempt interest received or accrued by the partnership during the year.” “Individual partners include this amount on Form 1040 or 1040-SR, line 2a.” The form is covered on the Form 1040 page. Taxable interest has its own box and its own line: “Report interest income on Form 1040 or 1040-SR, line 2b.” The same distinction for a bank or broker form is on the 1099-INT box 1 page.
Code B, other tax-exempt income
Code B reports tax-exempt income that is not interest. The rule is shorter: “Increase the adjusted basis of your interest in the partnership by the amount shown, but don’t include it in income on your tax return.” One kind comes with a statement. “The partnership will attach a statement for the amount included under code B that’s exempt by reason of section 892 and describe the nature of the income.”
Code C, nondeductible expenses
These are costs the partnership paid that no partner can deduct. “The nondeductible expenses paid or incurred by the partnership aren’t deductible on your tax return.” They still matter, because basis goes down. The basis worksheet has a line for them: “Enter as a negative amount any nondeductible expenses reported in box 18 of Schedule K-1.”
Why basis matters and an illustration
Basis decides how much loss can be used and when a distribution turns into gain. The instructions state the loss rule: “Generally, a partner may only claim their share of a partnership loss (including a capital loss) to the extent it doesn’t exceed their adjusted basis in the partnership at the end of the partnership’s tax year.” And the record-keeping duty: “It’s the partner’s responsibility to track and maintain the information necessary to figure their adjusted basis in the partnership (also known as outside basis).”
A short calculation of the box 18 effects only, not an IRS example. A partner starts with an adjusted basis of $50,000. Box 18 code A shows $2,000 (which increases basis) and code C shows $500 (which decreases it). The arithmetic is $50,000 plus $2,000 minus $500, which is $51,500. The amount of $2,000 is also reported on line 2a of Form 1040 as an item of information, and the amount of $500 is not deducted. The figures are made up and ignore every other K-1 item.
The capital account on the K-1 does not replace this record: “Although the partnership provides an analysis of the partner’s capital account in item L of Schedule K-1, that information is based on the partnership’s books and records and can’t be used to figure the partner’s adjusted basis.”
Tax-exempt income and the net investment income tax
The net investment income tax is figured on its own form. A partner who needs it can start with the Form 8960 page and the net investment income tax page.
The limits that apply before box 18
The instructions list the limitations on partnership losses in a fixed order: “These limitations and the order in which you must apply them are as follows: the basis limitations, the at-risk limitations, the passive activity limitations, and the excess business loss limitations.” The Part III amounts are shown before any of that: “The amounts shown in boxes 1 through 21 reflect your share of income, loss, deductions, credits, and other items from partnership business or rental activities without reference to limitations on losses or adjustments that may be required of you”.
Which revision applies
The edition read for this page is the 2025 Partner’s Instructions for Schedule K-1 (Form 1065) and the 2025 Schedule K-1 (Form 1065) itself, which are the revisions irs.gov served when they were read on 2026-10-16. Check the revision printed on the Schedule K-1 you received and the matching instructions, because a later edition can change the box layout, the code letters and the reporting lines.
Common mistakes
- Leaving code A off Form 1040 because it is not taxed. The instructions say individual partners include the amount on Form 1040 or 1040-SR, line 2a, as an item of information.
- Including code B in income. The instructions say to increase basis by the amount shown but not to include it in income on the tax return.
- Skipping the basis step for code C. The instructions say the nondeductible expenses aren’t deductible on the return and that basis decreases by the amount.
Related: Schedule K-1 (Form 1065) boxes explained, Form 1040, 1099-INT box 1 interest income, Form 8960 net investment income tax, and net investment income tax.
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Answer againSources
- 2025 Partner’s Instructions for Schedule K-1 (Form 1065): https://www.irs.gov/pub/irs-pdf/i1065sk1.pdf
- Schedule K-1 (Form 1065) (2025), Partner’s Share of Income, Deductions, Credits, etc.: https://www.irs.gov/pub/irs-pdf/f1065sk1.pdf
Read from the IRS documents linked above on October 16, 2026. General information, not tax advice. Your own facts decide the outcome, and a preparer, the account provider or the IRS is the right place to confirm anything consequential.