K-1

But the strangest thing happened today – you opened the mail and there, with your name on it, is a tax form you’ve never seen: Form K-1. You weren’t expecting it, you never received one before, and you just got it, only a month before the tax deadline.

You: What gives?

A K-1 is a tax form distributed by many partnerships, S-Corps, estates, and trusts.  If you are a general or limited partner of a partnership, a shareholder in an S-Corp, or the beneficiary of an estate or trust, you’re likely to receive a K-1.

You: But what is it?

A K-1 is just like a W-2 or other tax form.  You use the information provided on the form to accurately complete your tax return.  Except as illustrated in the opening scenario, K-1s are often distributed much later in the year than other tax forms.

You: Why do they arrive so late?

In order for the entity to send you the K-1, it first needs to complete its own tax return.

You: Huh?

For example, a partnership must prepare its taxes- its partnership tax return – before it sends out the K-1s to the partners.   The due date for most partnership tax returns is March 15. Consequently, K-1s are often received much later than other tax forms. Furthermore, like individuals, partnerships can request extensions of time to file, often until September 15.

You: So I might not receive a K-1 until after April 17, the deadline for my tax return?

Indeed, it’s not only possible, it happens routinely.

You: So how do I plan for that?

Most people who receive K-1s know they will receive them.

You: How do they know?

It’s rare to own a partnership or be a trust fund kid and not know it.

You: I suppose you’re right. So if get one of these K-1s, what would I do next?

Once you’re ready to start your tax return, collect all your tax forms, including any K-1s. If you’re using tax software, the program will tell you what you need to do with each form. TurboTax easily guides you through entering items reported on your K-1 and puts the information on your proper tax forms.

So, don’t lose too much sleep; the K-1 is, ultimately, just another form used to complete your taxes and report your income to the IRS.

To simplify this topic a bit, I’ll break this topic down to three sub-categories; wills, designated beneficiaries, and trusts.

Wills

A will is a relatively inexpensive (sub $500) first step in the proper handling of your affairs after your death. In it, you make known your desire for guardianship of your children, as well as who you want to get your possessions after you die. In your will you also need to name the executor of the will. Ideally, this is someone whom you trust and has the ability to serve in this position. Upon your passing, the executor needs to settle the finances of the estate including the payment of any debts and taxes, collection of any money owed to the estate. And finally, disburse the assets according to the terms of the will.

Often the same attorney who prepares your will also will offer you what is called a “living will,” the document that spells out your wishes regarding life prolonging medical treatment. Don’t pass on this important document; it will save your family from a very tough decision.

Designated Beneficiaries

A little discussed aspect of estate planning, the designated beneficiary may be the main conduit for much of your estate to pass. This refers to how accounts themselves can have a beneficiary which takes priority over any wishes expressed in your will. Retirement accounts including 401(k), IRA, and others are in this category. It’s important to consider this for a number of reasons. As time passes, you might have updated your will. That’s great, but did you update your 401(k) at work, or does it currently list the spouse you had 25 years ago? The people listed as beneficiaries on the account are who will inherit your money, not the people listed on your will. Not all 401(k) administrators will allow a non-spouse to take withdrawals over their lifetime, some offer a maximum 5 year payout.  This is one of the factors you should consider when leaving money in the 401(k) of a former employer or transfer it to an IRA. The bottom line – make it a habit to check your beneficiaries on your retirement accounts or any accounts with “pay on death provisions.” This will save those who survive you from wondering why a former spouse or friend you haven’t spoken to in decades was the recipient of your account.

Trusts

With the exact details of the estate tax in a bit of flux right now, no one can be certain what the exemption will be or whether or not there will even be an estate tax next year. Still, there are a number of uses of a trust that are somewhat independent of such changes in the laws. First, the Special Needs Trust (Also called a Supplemental Needs Trust) allows you to set aside money for a beneficiary who has a disability. If they received the funds outright, they might be disqualified from receiving government assistance. This is a way to leave them additional funds without impacting their benefits. Another common use for a trust is a Spendthrift Trust. You may feel that one or more of your beneficiaries isn’t ready to handle a windfall. This trust will allow you to leave the money in a way that will restrict withdrawals, typically to 5% of assets in the trust. Wording can be included to provide for unusual expenses such as medical bills or home repairs at the discretion of the assigned trustee. In April ’08 I wrote a post titled “On my death, please, take a breath” in which I describe a situation where such a trust could have helped avoid a large tax bill.

This article is an introduction only. The issues surrounding estate planning are often very sensitive. Wherever family and money are concerned one often needs to tread lightly. If you have a specific situation you’d like to discuss, ask in the comments as people are happy to help, but keep in mind, ultimately you need to work with a professional to be sure your will and trust is properly executed.