#71: K-1s for Dummies

Episode Summary:

In this episode of the Teaching Tax Flow podcast, hosts Chris Picciurro and John Tripolsky jump into the complexities of K-1 forms with a blend of expertise and humor. Designed to capture the interest of taxpayers and professionals alike, the episode breaks down the purpose, importance, and timing of K-1 forms, which are crucial for individuals involved in partnerships, S corporations, and certain types of trusts and estates. The conversation transitions smoothly from explaining what K-1 forms are to offering actionable advice for those who receive or issue them.

Chris provides an insightful overview of how K-1 forms act as the W-2 equivalent for entities that don’t pay federal income tax themselves but rather flow through profits and losses to their members. He emphasizes the significance of timely actions, the potential penalties for missing deadlines, and the benefits of working with a tax professional. The hosts also explore scenarios such as extending personal tax returns when K-1s are delayed and the implications of entering into business partnerships without an understanding of these forms, emphasizing that preparedness and communication are critical in handling K-1s effectively.

Key Takeaways:

  • K-1 forms are essential documents for individuals involved with flow-through entities like partnerships, S corporations, and certain trusts and estates, detailing their share of income, deductions, or credits.
  • They should be treated with the same importance as a W-2, and recipients may need to extend their tax filings if K-1s are delayed.
  • There can be significant penalties for entities that fail to provide K-1 forms by the March 15th deadline, or a later deadline if an extension is filed.
  • Effective communication and having tax matters organized upfront are vital for both issuers and receivers of K-1 forms.
  • While K-1 forms add complexity to tax filing, they can also present tax planning opportunities through income shifting and other strategies.

Notable Quotes:

  • “K-1 is the W-2 equivalent for people that are involved in what we call transparent or flow-through entities.” – Chris Picciurro
  • “You’re better off delaying things and getting things done the right way instead of doing things, taking shortcuts.” – Chris Picciurro

Episode Sponsor: The Mortgage Shop

0:00:00 – (Intro) welcome to the teaching tax Flow podcast, where the goal is to empower and educate you to legally and ethically minimize taxes paid over your lifetime.
0:00:17 – (John Tripolsky): Hey, everyone, and welcome back to the podcast, episode 71. Today we are going to dive headfirst into k ones. What they are, what they aren’t, and when you can expect them. But before we do that, as always, let’s take a brief moment and thank our sponsor on this episode.
0:00:42 – (Ad Read): This podcast is sponsored by the mortgage shop. Are you looking to qualify for an investment credit loan without jumping through hoops? That’s easy. They have loans with LTV up to 89.99%. Exploring their products and discovering how they can work for you is simple. Just visit mortgage.shop or call 865-325-2566 and tell them TTF sent you.
0:00:50 – (John Tripolsky): All right, folks, let’s jump into it. Let’s talk about these k ones. But you already heard about the sponsor. Now let’s hear from the man himself, Chris Pakiro. Welcome back to the show, sir. How are we today?
0:01:13 – (Chris Picciurro): Oh, it’s awesome to be back. Johnny T. How are you, sir?
0:01:17 – (John Tripolsky): Doing great. Doing great as always. And I’m going to start this one off with a dad joke. Dad joke of the day. Probably going to hear my k nine barking in the background. But that’s not what we’re here to talk about. We’re here to talk about these k ones.
0:01:32 – (Chris Picciurro): That was rough. That was rough. The only thing I would give you is maybe you should have said, what would you get if a w nine in a k one form had a baby? You’d have a k nine.
0:01:43 – (John Tripolsky): Oh, I forget about that guy every once in a while. I think that came up in one of our earlier episodes and I forgot who we were doing it with, but I think they just started busting out laughing. Anyways, let’s get down to business. So, Chris, give us really your definition, your outline of what exactly a k one is for those of our audience, our community, that may have never heard of one before.
0:02:07 – (Chris Picciurro): Right? So if you have not heard of one, you’re not alone. But it is a very common form. K one is an IRS form that reports a lot of information that is vital to your tax preparation. And the best way I could describe it is that when you are an employee of an organization, your earnings and your tax withholdings and a bunch of other stuff is reported on a form. That form is called a w two. The k one is the w two equivalent for people that are involved in what we call a transparent or a flow through entity.
0:02:50 – (Chris Picciurro): So let me paint a picture for you. There are certain types of entities that don’t pay a federal tax. Any type of federal tax on income earned by that entity or were losses and deductions is paid for on a personal tax return in general. So, for instance, entities taxed as a partnership, which would be a partnership, or a multi-member limited liability company or LLC. Entities taxed as an S corporation.
0:03:26 – (Chris Picciurro): Shameless plug. Check out our s corporation, podcast, episode, and trusts and estates. These are the typical entities that they do not pay a federal tax. If there’s taxable income, deductions, credits, et cetera, et cetera, those are all allocated to the beneficiaries or owners, depending on what type of entity it is, and reported on a form k one. So many people receive a k one. We have people that receive many, many K ones.
0:04:04 – (Chris Picciurro): The activity on the k one is reported on your personal tax return. So let me make a real easy example, John. Let’s say you and I decide to hit the gym and we decide we’re going to start a new LLC, and you and I start a new LLC where we’re professional dancers. Yes.
0:04:26 – (John Tripolsky): Oh, man. Don’t give away all of our secrets now.
0:04:30 – (Chris Picciurro): So the LLC, we own it 50 50, and we earn a total of $500. Now, that’s $1,000 for the year, because we’re terrible dancers and the only people that would hire us would be very desperate.
0:04:48 – (John Tripolsky): Or they’re blind, let’s be honest.
0:04:50 – (Chris Picciurro): Well, yeah, they’re very few. But anyway, so $1,000 comes into the LLC. Let’s say we have expenses of $100. So the LLC itself has a $900 profit. If the operating agreement of the LLC says you and I split the profits, you and I would each receive a k one for reporting $450 of net income, and we would have to pay tax on that. We couldn’t tiptoe around it, if you will. I know that’s an awful joke. We’re talking about dancing, but you know what?
0:05:24 – (John Tripolsky): Let’s be honest about this one, too. We got to have a good time doing this. I mean, for gosh sakes, we’re talking about taxes and dancing on this show.
0:05:32 – (Chris Picciurro): So we can’tiptoe around. You and I would each get a k one. The k one would report $450,000 of the net income, and you and I would be responsible for reporting that amount on our tax return. Now, that’s the most basic example that I could make. But that k one form really gives us a lot of information as a tax professional on a lot of things. So it’s not just income, it’s deductions, special deductions like bonus or section 179 depreciation in credits.
0:06:06 – (Chris Picciurro): Sometimes credits could flow through the k one, like research and development credits, employee retention tax credits for solar. So anything that the entity that you’re involved with reports on its return would flow on your personal return deductions. Like I said, information about the section 199, a deduction. The k one is a pretty complicated form, and my advice would be is if you’re someone that’s receiving a k one or more than one k one, deeply consider working with a tax professional when it comes to tax preparation.
0:06:42 – (John Tripolsky): And, Chris, so these k ones, they really are the byproduct of a form 1065, if I’m correct on that one. But then let’s talk about timing for a minute. So the timing of when these are usually issued or are required to be issued, if I remember this correctly as well, is right around that middle of March, March 15. And they are received very similar to a 1099, I believe. Right. So everybody kind of sits and waits a little bit to get those 1099s in the email or in their inbox or in their mailbox. And that’s similar as well to these k ones, correct?
0:07:24 – (Chris Picciurro): That’s correct. So k1s are depends on the entity. I probably should have mentioned this earlier. A k one is part of a tax return for an estate or trust, which is a form 1041, an S corporation, a form 1120s, or entity tax as a partnership, a form 1065. So k ones are not. The difference between a k one and a w two is. The k one is part of an attachment to the federal tax return of foreign entity, where w two is a separate payroll tax filing from the entity.
0:08:03 – (Chris Picciurro): For partnerships and s corporations, those tax returns are due March 15, and thus the K ones are due March 15 to the recipients. Now, it is very, very common that these tax returns are extended, and they can receive an automatic six month extension till September 15 relatively easily. I would argue that at least half of all partnership and s corporation tax returns are extended beyond March 15. And a lot of times, it’s good tax planning.
0:08:32 – (Chris Picciurro): This is where it gets tricky, though. You want to make sure that you do extend that tax return, because the penalty for not filing a partnership or s corporation tax return by March 15 on the federal level is approximately $200 per member per month. So per k one, meaning if, let’s say you get together with twelve buddies, you guys buy an apartment building, oh, we got a multi member LLC and in April 5, you decide, oh, we probably need to talk to a CPA or a tax professional to get the tax return prepared.
0:09:07 – (Chris Picciurro): You already went past the March 15 deadline. Twelve times $200. You’re already into the $2,400 of penalties. So key takeaway here. K one is part of the federal tax return. You will be issued that if you’re a member or scorp owner, or if you’re a beneficiary of an estate or trust. One more thing to point out. A k one could be issued to a non individual. An LLC could be a member of another LLC. So sometimes the K ones. K ones are issued to whoever the owner is. And what’s put on the k one really depends on the documents for that entity. So for s corporations, it’s pretty straightforward.
0:09:52 – (Chris Picciurro): But when we’re talking about multi member llcs and partnerships, so entities tax as a partnership. For a partnership, it’s the partnership agreement. For the LLC, it’s the operating agreement. Those documents tell the tale of what goes on that k one. So, John, in our dancing example, our operating agreement might say, well, John’s a much better dancer, he’s got better flexibility, he gets 60% of the profit and I only get 40% of the profit. So if k one would report 60% goes to John, only 40% goes to myself.
0:10:24 – (Chris Picciurro): The estates and trusts, those are due April 15, or obviously little later if there’s a federal tax holiday or a weekend. So those due dates are more in line with a personal tax return.
0:10:36 – (John Tripolsky): Well, sir, let me start off by saying I appreciate your flexibility and distribution there, but let’s look at regarding timing again. I know we spoke on that a little bit, but let me paint a picture, as I believe you like to say, on a situation. So say, I, John Taxpayer, am a diehard, refuse to file a tax deadline extension, and I’m waiting for a Kate one. I’m expecting this middle of march. Here I am waiting, waiting, waiting, patiently waiting, and we’ll call them. The issuing party decides to file an extension on their end. So they have not filed their tax forms.
0:11:21 – (John Tripolsky): As a result, no k ones are being issued. So what do I do on my end regarding actually filing my taxes for the year? Do I make an assumption on what that’s going to be, or I should say the amount on that k one? Where do we go from there as far as how do I handle this situation? Since obviously the issuing party filing that extension, I am in zero control of.
0:11:49 – (Chris Picciurro): Right at that point, what you would do is you would file a federal tax extension. And then you would ask whoever is in charge. So for an entity like that, like, let’s say it’s a multi member LLC, you always have a tax matters partner. You’d ask the person that’s kind of in charge of getting the tax return together, what is expected, what is the expectation for my portion of the income and deductions?
0:12:13 – (Chris Picciurro): And if it’s going to create a situation where you owe on your personal tax return, then you would extend your personal return and make a payment to cover what the expectation is. If it’s a loss or it’s going to just increase your refund, you’re just going to have to wait it out. And that’s where you’re going to have to understand that when you get involved with entities, that issue K was that it’s going to just take a little while. It’s not like the best way I could describe it, John, is think about if you have a w two and a mortgage statement, you could have your tax prepared, or you could prepare yourself relatively quickly, so you could just throw it in a microwave, right?
0:12:53 – (Chris Picciurro): But when you have a lot more complex situation, when you’re making a four course meal, you’re not going to make a four course meal in a microwave. You need more time. So if you’re sitting down for that four course meal, you can’t expect that you’re going to have the food in a minute to 2 minutes.
0:13:10 – (John Tripolsky): Great explanation. Great explanation of that. And kind of reiterate a few things. I mean, it really does sound like it all boils down to communication. Like many things in life, communication is key. But we are making the assumption. But I’m going to assume that getting into business with another party like that K ones are being issued, they probably have a pretty good idea, right. So if you reached out to them, they’d probably be able to say, yes, this is roughly where you’re at or what you can expect on your end. Correct.
0:13:43 – (Chris Picciurro): You should. You should have a really good idea. And that’s where we do a lot of estimating what that’s going to be a lot of in our private CPA practice, a lot of these partnership tax returns are on extension because typically they’re purchasing real estate assets and it’s going to take a while to get the cost segregation study done for that. It could take a long time to even collect information to prepare the K ones.
0:14:10 – (Chris Picciurro): The K one has the taxpayer’s name, either Social Security number or ein, and a mailing address. So those are things that have to get collected. So let’s take the angle of John. Let’s say you said, I’m going to get twelve buddies together and I’m going to buy this apartment complex, and everyone pitches in, let’s say ten grand, and then you get, I don’t know, probably not much for ten grand. Let’s say everyone puts in $100,000, and then you finance some of it, you get the deal done. It’s February and you’re thinking, oh, gosh, I’ve got to issue these k ones.
0:14:42 – (Chris Picciurro): What do you not have? Unless you know what you’re doing, you don’t have everyone’s Social Security number, name, you just have their money wired. So those are things, once you start, if you’re someone out there listening, that you want to put together a partnership or an entity, make sure you get that information in advance, not that someone’s going to hide that from you yet. It’s important to have that because it’s just like when you’re back to the cooking example, you can’t take something in the oven and say, oh, I should have put, the pizza is almost done. I should have put x on it.
0:15:17 – (Chris Picciurro): It’s already cooked. It’s going to be bad if you just slap raw onions on it. Unless you’re a wacko and you like raw onions on your pizza, that’s where that comes into place. And if you are someone that’s putting together a partnership, what you want to do is you want to get w nine. So very similar when you issue a 1099 to solve, but you get someone’s w nine information. That’s the IRS form where someone would submit that to a person putting it together. So putting the k ones together.
0:15:50 – (Chris Picciurro): Yeah. You should have an idea of what the profit loss is going to be. And that way you can either extend your personal return, because if you file a return without the k one now you’re going to have to amend the return, and that’s not fine.
0:16:10 – (John Tripolsky): So here’s a question or series of questions on a situation, fictitious situation, that I know will absolutely make your CPA just heart cringe. Let’s say there are two individuals going to business with each other, so they’re forming a partnership entity, and they have no idea what a k one is before they listen to this podcast. Of course. No idea what a k one is, no idea that these need to be issued.
0:16:42 – (John Tripolsky): The questions are, a, is that okay? And really, b, how do you go back and fix this? Kind of unravel all the boo boos that were made, say, over the past couple of years. And I say this too, because I know there’s people in our community that this has happened to or may actually be likely in that path or going down that path, or will be going down that path, and they don’t know exactly what they’re getting into. So what might we be looking at with a situation like that?
0:17:16 – (John Tripolsky): Taking myself into consideration, in full transparency, about 25 years ago or so, me and a buddy got into business, decided we’re going to sell race car region parts together. We basically just bought our own stuff. Registered, just registered as an LLC at my parents house at the time. Obviously, I moved out from there, and they kept getting a bunch of crap in the mail. Buy pens, buy notepads, buy t shirts, everything under the sun.
0:17:41 – (John Tripolsky): Sorry, mom and dad. So what might somebody be looking at if they get themselves, or will be getting themselves in a situation like that?
0:17:50 – (Chris Picciurro): When you form an LLC and you obtain a federal identification number from the IRS, you state, is it going to be multi member or single member? If you put multimember, then it’s going to issue you that federal identification number and let you know that there’s a tax return due March 15 of the next year. That’s the first step. So if you do that and you’re sitting there thinking, oh gosh, I don’t have all the partners information, then you’re going to need to file an extension for that partnership tax return.
0:18:19 – (Chris Picciurro): That’s your best option until you can get all the information.
0:18:22 – (John Tripolsky): Makes sense. Makes total sense, really. It’s pretty cut and dry, right? You just got to pay attention.
0:18:28 – (Chris Picciurro): Exactly. You just need to know. I mean, that’s where once you get to the point where you’re having multiple people within a business, even if it’s two spouses, you really need to work with a tax professional to kind of put a bow on this. This podcast sounds like a bunch of doom and gloom, like, oh, gosh, k one forms. There’s a lot of opportunity with k one with multimember entities, especially multi member llcs or partnerships, to take advantage of some tax strategies and just, I’m going to do the name off a few income shifting. Right?
0:19:06 – (Chris Picciurro): I can own 50% of an etsy, you can own 50%, but I get allocated more or less income than you. I could get allocated certain deductions and credits, and you don’t because maybe they’re going to just proper planning. Right. You might be doing more work than I am with it. So income shifting is an opportunity. There are some tax strategies that push through deductions in credits through k ones that could really help you out as well. So there’s just a lot of opportunity also in the tax planning side of things with more advanced entities, and most of them are going to be your partnerships and llcs taxed as a partnership.
0:19:58 – (Chris Picciurro): But I think that the best thing to do is one as the takeaways. If you’re someone that receives k ones, don’t be afraid of them. They’re forms that a seasoned tax professional is very attuned to working with. Make sure you submit them to your tax professional and don’t be alarmed if it’s going to take a while to get them. These are very complicated forms. They’re not just cranked out like a w two two. If you’re someone that has to issue k ones, make sure that you get all of the members and partners and scorp owners information before when the entity is formed, not after the fact.
0:20:39 – (Chris Picciurro): If you don’t have all of it, take a breath. Just file an extension for the entity and make sure you get things done the right way. You’re better off delaying things and getting things done the right way instead of doing things, taking shortcuts. Because just like in life, when you take shortcuts, it always comes back to bite you in the high knee. Finally, remember March 15. Now, if it’s on a weekend or a holiday, is the due date for any form 1065 which is a partnership return, that’s going to be your partnerships and multi member llcs.
0:21:12 – (Chris Picciurro): Scorp returns form 1120s. And if you get to that point or you’re even close to that point, file the extension. Finally, remember, the k one forms are not separately filed. They are filed with either a partnership return, Scorp return, or in a state or trust.
0:21:35 – (John Tripolsky): Excellent, excellent. And thank you as always for diving into the details with us. I know, I appreciate it. I know our audience appreciates it. We get great feedback. So that being said, believe it or not, I don’t have anything else to add to this. I’m actually going to shut up because you did such a good job. So thank you for that. And let’s go ahead and close it out like we prefer to do every week here on the show.
0:22:04 – (John Tripolsky): We will see you back here, same time, same place, different topic, next week here on the Teaching Tax Flow podcast. Hey everybody, John Trapalski here from the teaching tax flow team. Just wanted to say thank you again for joining us on this episode. As we looked at k ones with the man himself, Chris Pecure, founder, educator, and all the titles above, here at teaching tax flow. We appreciate the insight and hopefully you got some good notes from this.
0:22:41 – (John Tripolsky): If you came into it having no idea what a k one is, hopefully now you do. If you came into the show thinking you knew a lot about k ones and now you got a little extra knowledge nugget. Either way, we’re glad to have you. Be sure to hop onto that defeating taxes private Facebook group you just go to defeatingtaxes.com sends you directly there. Ask any questions that you may have. That community is made up of tax professionals, taxpayers, many, many people that we work with at TTF on a daily basis.
0:23:16 – (John Tripolsky): You name it, they’re on there. So again, don’t be afraid to ask those questions. We will see everybody back here again very soon.
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