For most people, tax time can be a headache—though for earners with traditional compensation packages, it can at least be fairly predictable (W-2 wages, withheld taxes, 401(k) contribution deductions, etc.). If you’re a business owner, partner, or investor in a private company, however, your paperwork might include a Schedule K-1 form (or just K-1, as it’s sometimes called).
If you’ve never received a K-1 form before, you may be wondering how this fits into the rest of your tax filing responsibilities—and most importantly, how it impacts your overall tax bill. Below we are explore what a K-1 form is, how it’s different from other common tax forms, and what investors or certain equity compensation earners need to know.
First, Why Does a Schedule K-1 Exist?
In other words… What, exactly, is the purpose of a K-1 form?
As pass-through entities, LLCs and other partnerships are not themselves subject to income tax—yet the IRS wants its share of the pie. A K-1 is how a partnership or S corporation reports to the IRS how different income types (dividends, capital gains, profits, etc.) or losses are allocated among partners and shareholders, whether or not such amounts are actually distributed. Rather than the business or partnership being responsible for paying taxes as an entity, the tax liability is split among the partners or shareholders. Note that a K-1 is also used to report income distributions from trusts and estate to beneficiaries.
The business owner (or their tax professional) fills out an applicable K-1 form for each individual shareholder or partner and files it with the IRS. Each taxpayer receives a copy of their K-1, which they then use to complete their own tax return.
In this way, a K-1 works similarly to a traditional W-2 (which is used to report salary wages and withheld income tax). The employer is responsible for filing the form, and the employee must wait to file their taxes until they receive the completed form from their employer.
A K-1 is prepared for each relevant individual—partner, shareholder or beneficiary. A partnership files a Form 1065 which is the partnership tax return that contains activity on each partner’s K-1. An S corporation reports activity on Form 1120. Trusts and estates report the K-1 activity on Form 1041.
In Terms of Equity Compensation, Who Needs to Complete a K-1 Form?
A Schedule K-1 form must be filed by pass-through entities including partnerships and S corporations. If you’re a partner or shareholder in this type of entity (or you’ve invested in this type of entity), a completed K-1 form will be issued to you, which you must then include in your tax return.
That being said, partners or investors don’t have to prepare the K-1 form themselves, rather they must use the information provided on the issued form to complete their individual returns.
The information provided on a K-1 form will be used to either increase your tax liability (if additional income is reported) or potentially reduce it (if losses or deductions are reported).
If a loss is recorded, partners can actually carry that loss forward to deduct against future income. Here’s an example of what that might look like for a partnership filing a Form 1065:
Say you and two other people form a partnership, which reports losses of $50,000 each year for two years in a row. However, on your third year in business, the partnership makes a profit and the total income reported is $400,000. While your partnership files a K-1 form for each partner every year, no tax liability was owed for the first two years in business (since losses were reported).
Now that you’ve earned a profit in year three, the partnership will report the $400,000 in profit on the K-1, but deduct the $100,000 in previous losses ($50,000 per year x2). For year three, the partnership’s taxable income from the K-1 filing drops to $300,000, which is split among the partners based on their share of the partnership. Each partner is then responsible for paying income tax on their portion of the profit, based on their own income tax bracket—meaning you may all be taxed at different rates, depending on your total taxable income for the year.
It’s also important to note that a partner or shareholder can earn different types of income on their Schedule K-1, from rental income to interest and dividends, capital gains, and more. As such, it’s possible that the income included on a K-1 will be taxed differently, depending on what type it is. In fact, income reported on a K-1 can even trigger alternative minimum tax, which is a parallel tax system that generally only applies to high earners.
Does a Schedule K-1 Form Impact State Tax as Well?
Yes, the income reported on a Schedule K-1 form can trigger state taxes, as well as international tax (if you’re invested in a private foreign company).
If the company did business in another state, for example, you may be required to complete a non-resident state tax return if a K-1 was filed for that state. However not all states collect income tax, so check with your accountant before proceeding with a non-resident state return filing.
What’s Included on a Schedule K-1 Form
A Schedule K-1 Form is used by company shareholders or partners to report what’s been passed through the company to the individual taxpayer including:
- Income
- Losses
- Deductions
- Tax credits
Remember, it’s only applicable to business owners, shareholders, and partners of businesses established as pass-through entities like LLCs, partnerships, and S corporations.
As we mentioned above, if you choose to incorporate private investments (which may also be considered alternative investments) in your portfolio, some of your income may be reported on a Schedule K-1 form as well.
If you’ve never received a K-1 form before, it’s because you have never been a shareholder or partner of an LLC, partnership, or S corporation. W-2 employees or 1099 contractors of these types of businesses won’t receive a K-1 form (unless they’re simultaneously W-2 employees and shareholders/partners, which can be the case for some business owners).
A K-1 form comes in a few different formats, depending on the business type and other factors. These include:
Form 1065: Called a U.S. Return of Partnership Income, this form is specifically for partnerships including limited partnerships, general partnerships, limited liability partnerships, or multi-member LLCs. A Form 1065 will need to be completed for each partner, and it’ll indicate each partner’s share of the business’s income, capital gains, deductions, etc.
Form 1120-S: If your company operates as an S corporation, they’ll be required to file a Form 1120-S K-1 form for each shareholder. The form indicates what percentage each shareholder received of the business’s income, capital gains, losses, deductions, and credits. If the S corporation is a one-person company, the percentage would be 100%, for example.
Form 1041: This type of form is filed by an estate or trust if it generated income after the owner passed away, but before the assets could be transferred to the intended beneficiaries. Rather than come from a business partnership or corporation, this type of K-1 form must be filed by an estate’s executor or a trustee. For the purposes of this article (and managing the tax liability of your equity compensation and/or alternative investments), we will not be referencing this particular form when talking about K-1s.
What Information Is Included in a Schedule K-1 Form?
The good news is, a Schedule K-1 is only one page long (though, of course, it still requires time and energy for partners or business owners to record all relevant information for each receiver).
Whether a Form 1065 or 1120-S applies to your specific circumstances, each consists of three sections:
Part 1: The person filing the form will need to first provide information about the partnership or corporation, including the employer identification number (EIN), address, and how shares are divvied up.
Part 2: In this section, the filer will need to provide information about the shareholder or partner receiving the form (meaning it’ll differ for each form filed). This includes their Social Security number (or other identifying number), contact information, percentage of ownership, etc. It’s worth noting that Part 2 is much more extensive on the Form 1065 (partnership form) than the Form 1120-S—likely because the IRS is more interested in partnership information for pass-through entities than shareholders.
Part 3: In the final section of the form, the person filing will provide details regarding income, deductions, dividends, gains, and anything else relating to the business’s financials that would have passed through to the individual taxpayer.
Examples of form fields you’ll find in Part 3 include:
- Ordinary business income or losses
- Net rental real estate income or losses
- Interest income
- Ordinary or qualified dividends
- Royalties
What Is a 1099 Form?
For investors or employees with equity compensation, it may be helpful to briefly compare the Schedule K-1 form with the more commonly seen 1099 form.
A 1099 form comes in a few different options, but generally it’s used to report income you’ve earned that does not come from an employer. Like a K-1, it can report information regarding income, dividends, interest earned, returns, and other financial factors.
All 1099 forms must be issued by January 31 (or February 15, in some cases). By comparison, K-1 forms are due on March 15, making them one of the last forms a taxpayer tends to receive before filing their return.
Common examples of 1099 forms include:
- 1099-NEC: If you’re a freelancer or contractor who’s earned more than $600 in “nonemployee compensation,” you may receive a 1099-NEC from an individual or business.
- 1099-MISC: This is used to report income exceeding $600, typically in the form of rental income or royalty payments. Freelancers and contractors may also receive their 1099 as a 1099-MISC, as opposed to a 1099-NEC.
- 1099-G: If you received a refund from your state or local tax authority in the prior year, you’ll get this form in the mail.
- 1099-B: This is for capital gains or losses.
- 1099-DIV: If you received dividend income or capital gains distributions, it’ll be reported on your 1099-DIV.
- 1099-INT: Any accounts or investments that produce interest will be required to send out a 1099-INT form.
In terms of equity compensation, you’re most likely to come across form 1099-NEC and 1099-B—though keep in mind that in some cases, your income from equity compensation is reported directly on your W-2. A 1099-NEC may be necessary if you are not a fulltime employee for the company (say you’re a consultant), while a 1099-B is typically used to report gains or losses from the sale of securities including from restricted stock units (RSUs), non-qualified stock options (NQSOS) or incentive stock options (ISOs).
There may be other instances where a 1099 form is required in conjunction with equity compensation, which you’ll want to discuss with your tax professional.
A Quick Note on Alternative Investments and K-1 Forms
We don’t want to go too far down the rabbit hole of alternative investments here, but they’re worth mentioning as part of the K-1 form conversation.
If you’re interested in expanding your portfolio beyond traditional assets (stocks, bonds, and cash equivalents), the world of alts might be appealing.
Generally speaking, private equity gives accredited investors the opportunity to participate in investments that may yield higher returns than traditional investment methods, though the risk is typically higher as well. Not to mention, these investments tend to tie up capital for long period of times (often multiple years) and lack the transparency of more heavily regulated investments, like publicly traded stocks.
Keep in mind that if you choose to invest with private equity firms, venture capital (VC) firms, or hedge funds, these may be structured as limited partnerships—meaning you may receive a K-1 form at tax time.
Tips for Managing Your K-1 Form
The biggest issue with K-1 form filing is that they are historically completed at the eleventh hour—and often past the March 15 deadline. It’s worth noting that before tax rule changes in 2017, the K-1 deadline was April 15. Still, it’s highly likely a K-1 will be the final piece you’ll receive of your tax return puzzle—which can be frustrating for many taxpayers.
To speed up the process, consider opting into digital delivery of your K-1 form. You may be able to access the document sooner via email or an online portal, as opposed to waiting for it to come in the mail.
Our biggest piece of advice is if you know you’ll be receiving a K-1 form, request a tax deadline extension for October 15th. This should provide you with plenty of time to get your documents organized and filed without incurring a late fee or penalty.
If you do plan on requesting an extension, you should still make a good faith payment before the April 15th deadline—especially if you know the income report on your K-1 will increase your tax liability. Remember, the filing extension deadline doesn’t apply to your final tax bill, meaning you’re still expected to pay your tax bill by April 15, whether you have your documents in hand or not.
Once you receive your K-1 form, you’ll be able to take the information provided and complete the Form 1040, which is what gets filed with your personal taxes.
We know for many high earners and investors, receiving a K-1 form for the first time can be confusing and stressful. While you’ll want to speak to an accountant or tax preparer to discuss the filing details and specific requirements, we’re here to help you make tax-focused decisions about your equity compensation and investments.
Don’t hesitate to reach out and schedule time to talk with our team to learn more.
This material is intended for informational/educational purposes only and should not be construed as investment, tax, or legal advice, a solicitation, or a recommendation to buy or sell any security or investment product.
The information contained herein is taken from sources believed to be reliable, however accuracy or completeness cannot be guaranteed.
Please contact your financial, tax, and legal professionals for more information specific to your situation.
Investments are subject to risk, including the loss of principal. Because investment return and principal value fluctuate, shares may be worth more or less than their original value.
Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results.
Talk to your financial advisor before making any investing decisions.
Investing in alternative investments may not be suitable for all investors and involves special risks, such as risk associated with leveraging the investment, utilizing complex financial derivatives, adverse market forces, regulatory and tax code changes, and illiquidity. There is no assurance that the investment objective will be attained.
