What is a K-1?

A K-1 is a reporting tool to the Internal Revenue Service. It is used by Partnerships, S-Corporations and Trusts to report the taxpayer’s share of income, deductions, and credits. A K-1 is similar to Form W-2 or 1099 in that the information provided informs the taxpayer of what has been reported to the Internal Revenue Service.

The K-1 is formally called Schedule K-1 for a particular type of business entity. The following tax entities are matched to the type of K-1 report

  • Partnerships           Schedule K-1 Form 1065
  • S-Corporations       Schedule K-1 Form 1120-S
  • Trust                        Schedule K-1 Form 1041

When a taxpayer becomes a partner, a stockholder in an S-Corporation, or a beneficiary of a trust (s)he becomes responsible to pay the taxes of these pass-through entities. Pass –through entities do not pay income taxes as they were granted this privilege upon application to the Internal Revenue Service. Each of the owners (partners, stockholders and beneficiaries) agreed to this assignment of income, deductions, and credits in the application process. The Schedule K-1 is used as the reporting document of the respected share of these types of income, deductions, and credits.

At the end of the IRS required reporting cycle (typically a calendar year) the entity prepares its tax return for the IRS and state. Attached to this tax return is a Schedule K-1 for each owner of the entity. In some publicly traded partnerships there are several thousand owners, similar to publicly traded stock corporations. Each one of these owners is sent a K-1. It often takes several months to complete this process and so many recipients of Schedule K-1 extend the filing date of their personal tax return. The most common example is the small business owner getting his business return prepared first then getting his personal tax return completed once the final information is known for his business.

The Schedule K-1 has three sections. The first section is identification of the entity involved in the relationship. The business entity identifies itself and informs the taxpayer of where the tax return was filed for reference.

The second section identifies the taxpayer (owner) and documents the percentage of ownership. In addition this section reports the type of owner for this return. Some partnerships are owned by other partnerships or trusts are owned by corporations and so on. When it reports about individuals, the K-1 informs the IRS where this individual lives (domestic or foreign) and what kind of role did this taxpayer play in the conduct of business. This is important to the taxpayer; if the taxpayer played an active role then the income assigned to the taxpayer is regarded as ‘Earned’ and therefore additional taxes (self-employment) are applicable. Seek guidance from your CPA as to the type of income you are assigned. In addition to the information about the taxpayer, this section tells the IRS the overall capital account status of the taxpayer and his/her responsibilities for debt. There are strict rules in relation to the business entity’s debt and if this debt is guaranteed by the taxpayer (which often is true for small business operations). In many cases, if the debt is guaranteed and the losses of the entity exceed the capital invested by the taxpayer, the taxpayer may still be able to take the loss as a deduction on his/her return.

The third section reports the respective types of income, types of deductions, and any credits the taxpayer is assigned. This is the heart of the report. It breaks out in a similar format as the personal tax return. Most of the lines report income in the various formats. The reader should understand that income comes in many different ways, some income is actively earned, some income is passive in nature (dividends, interest, rental income), and still others are associated with capital gains/losses. These gains and losses can take on different meanings and depending on the taxpayer’s situation, these gains and losses can be taxed at different tax rates. 

Once the income lines are done, the entity assigns deductions to the owner. Similar to the gains and losses, these deductions can be used against certain types of income and if not completely used, must be carried over to other tax years. Some of the deductions are not allowed as a deduction on the taxpayer’s personal return and some must meet certain thresholds to be deductible. Your CPA can assist you in understanding this information and how it relates to your personal return. Examples of deductions include charitable gifts, interest expense deduction, depreciation expense, and meals and entertainment expenses not allowed as a deduction for the business entity. Sometimes the income earned by the business was due to the active participation of the taxpayer, therefore, the taxpayer must include some or all of the income as self-employment income and the K-1 reports this information too. This triggers a Schedule SE to be attached to the personal tax return of the taxpayer.

The final area of the K-1’s third section identifies any credits and important information for the taxpayer. This information relates to how the assigned income and/or deductions are used by the taxpayer in reporting to the IRS. This information assists the taxpayer in filing a correct tax return and reducing errors on the personal return.

When a small business owner understands what a K-1 is, he can better understand the overall tax situation related to his business operation. Act on Knowledge.

Value Investing

Do you want to learn how to get returns like this?

Then learn about Value Investing. Value investing in the simplest of terms means to buy low and sell high. Value investing is defined as a systematic process of buying high quality stock at an undervalued market price quantified by intrinsic value and justified via financial analysis; then selling the stock in a timely manner upon market price recovery.

There are four key principles used with value investing. Each is required. They are:

  1. Risk Reduction – Buy only high quality stocks;
  2. Intrinsic Value – The underlying assets and operations are of good quality and performance;
  3. Financial Analysis – Use core financial information, business ratios and key performance indicators to create a high level of confidence that recovery is just a matter of time;
  4. Patience – Allow time to work for the investor.

If you are interested in learning more, go to the Membership Program page under Value Investing section in the header above. 

Join the value investing club and learn about value investing and how you can easily acquire similar results with your investment fund. Upon joining, you’ll receive the book Value Investing with Business Ratios, a reference guide used with all the decision models you build. Each member goes through three distinct phases:

  1. Education – Introduction to value investing along with terminology used are explained. Key principles of value investing are covered via a series of lessons and tutorials.
  2. Development – Members are taught how pools of investments are developed by first learning about financial metrics and how to read financial statements. The member then uses existing models to grasp the core understanding of developing buy/sell triggers for high quality stocks.
  3. Sophistication – Most members reach this phase of understanding after about six months. Many members create their own pools of investments and share with others their knowledge. Members are introduced to more sophisticated types of investments and how to use them to reduce risk and improve, via leverage, overall returns for their value investment pools.

Each week, you receive an e-mail with a full update on the pools. Follow along as the Investment Fund grows. Start investing with confidence from what you learn. Create your own fund and over time, accumulate wealth. Joining entitles you to the following:

  • Lessons about value investing and the principles involved;
  • Free webinars from the author following up the lessons;
  • Charts, graphs, tutorials, templates and resources to use when you create your own pool;
  • Access to existing pools and their respective data models along with buy/sell triggers;
  • Follow along with the investment fund and its weekly updates;
  • White papers addressing financial principles and proper interpretation methods; AND
  • Some simple good advice.

Value Investment Club

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