The current practice of K-1 reporting has led to significant complexity and risk associated with federal, state, and international reporting requirements. This includes many that practitioners understand, and others that creep up in the event of a sale of partnership asset. The authors walk through these complexities in this series of white papers.
Thomson Reuters and Crowe LLP entered into a strategic collaboration to help tax professionals address the burdensome manual work related to Schedule K-1 forms.
The authors are tax accounting specialists from Crowe:
Geralyn R. Hurd, CPA
John V. Woodhull, JD
Jonathan M. Cesaretti, JD
Kristin N. Kranich, CPA
The Four Dimensions of K-1 Aggregation: A Federal Overview
With a record of higher rates of returns and fewer public companies in which to invest, alternative investments have gained in popularity across a broad spectrum of investors. According to Institutional Investor, the alternative investment industry was nearly a $9 trillion industry in 2017 and is expected to grow almost 60% to reach $14 trillion by 2023.
The term “alternative investments” includes a wide range of non-traditional investments, including investments in venture capital, private equity, hedge funds, and other derivatives, as well as limited partnerships (LPs), limited liability partnerships (LLPs), and limited liability companies (LLCs). Each of these investment vehicles has its own unique reporting requirements that add a measure of tax complexity for all investors. However, the focus of the following discussion will be on partnership and LLC investments and on the tax reporting that flows from the Schedule K-1 of Form 1065 issued.
Tax complexities of partner reporting
1. No structure
Although it is clear that partnerships are required by statute to provide partners with the information necessary to compute their distributive share of partnership income and deductions from any trade or business, there are no real guidelines as to how that information should be reported. The old adage “If you’ve seen one, you’ve seen them all” couldn’t ring more falsely than in the context of a K-1. For those of us who work with a great deal of K-1 packets, the opposite is true – “If you’ve seen one K-1, you’ve seen one K-1.” Unlike nearly every other tax form, the K-1 has almost no structured format beyond the general demographic information. Even if you look at the K-1 Lines 1-20, it may seem pretty straightforward until you refer to page 2 that outlines the more than 200 data elements that a K-1 recipient may need in order to calculate federal taxable income. The Internal Revenue Service (IRS) even had to restart the alphabet for Line 20 to account for all the data to be reported on a single line. And that’s just federal. Adding state and international filing requirements, which have no required structure, means a lot of time spent pouring over a K-1 packet to make sure you’ve captured everything you need, for today and tomorrow’s reporting requirements.
2. No consistency
IRS published statistics through the 2016 tax year that show approximately 3.7 million partnerships with more than 28 million partners. Adding K-1s from S Corporations and Trusts, there are more than 40 million K-1s produced each year. It’s remarkable that while the data needed in a K-1 is fairly prescribed, the way in which this information is reported varies widely. Even K-1 packets received from the same tax preparers could be materially different in the format used and the details provided. Some reasons for this could be tiered partnership structures, specific partnership preference, and the time crunch usually experienced by tax preparers who often receive the last bit of information and need to distribute the next batch of K-1s within a day, if not hours.
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