Now that we are in the final weeks of 2011 everyone’s attention will soon turn to the preparation of their personal tax returns. As each tax season unfolds we tend to hear a common question, why am I always filing my taxes late? For many clients the cause is the dreaded Schedule K-1. A Schedule K1 is typically received from a trust, private business or private investment fund and is the scourge of every client and advisor!
Many individuals are engaged in certain business ventures including professional investment vehicles or are beneficiaries of certain trusts. The activities that typically occur in these vehicles are more complex than normal stocks and bonds. These activities require receiving and filing a Schedule K-1 form by the entity, which reports the distributed share of income from these relationships.
The primary problem with K-1’s is that they almost always arrive late. Most tax information reporting forms, like 1099s and 1098s, are required to be sent to taxpayers by January 31st. This is not the case with the Schedule K-1 form. Investors who receive K-1’s are lucky to receive them by the end of March. In addition, many alternative investment vehicles and closely held businesses that issue K-1’s file tax return extensions which result in all related K-1’s being delayed even longer.
So what is the cause of these delays? Many alternative investment strategies invest in active businesses, real estate, oil and gas, timber, commodities and futures. Due to the nature of these businesses, they often generate unique deductions and credits that must be reported on any number of obscure supplemental tax forms and schedules. Even with today’s computer technology, each form and schedule takes a tremendous amount of time to complete. With accountants facing tax preparer penalties for tax return errors, most accountants are unwilling to issue their K-1’s without a high level of confidence in the completed form.
Then why do individuals invest in Alternative Investments? Unfortunately, in today’s investment climate many of the unique business opportunities that are available to high net worth clients are only accessible through these vehicles. When properly structured, these opportunities can present an enormous upside that is not typically available to retail investors. As tax rates rise, many of these unique features become even more valuable and offer the liability protection that investor’s desire.
So the next time you get frustrated about the delay just remember we feel your pain.