Finding your K-1 balance

Ask a LP when they would like their K-1 to arrive this year and they’re likely to respond “yesterday”.

At the moment hundreds of private equity firms are in the process of preparing the Schedule K-1s, which provide US-based LPs with their allocation of a fund’s partnership income, deductions, gains and losses to meet their tax filing obligations. As any GP would be able to tell you, it’s a time-consuming exercise in light of the complexity of fund structures used today, the varying information needs of investors with different tax profiles and a greater number of information requests from LPs on the K-1 that are often pages of questions long.

Many LPs are sending these questionnaires to their GPs in December and January, requesting the K-1 (or at least a draft K-1), along with the completed questionnaire to be delivered as early as mid-February to meet a 15 April filing deadline. GPs may scoff at the request, but failing to communicate a more realistic timetable upfront can damper investor relations. Sources tell PE Manager that GPs don’t always give their full effort when answering unreasonable K-1 requests from less influential LPs, or at times even ignore the request completely. 

Clearly that can leave investors annoyed. To be fair, some suggest strategic LPs are making early K-1 requests in the hopes a percentage of GPs will be able to deliver on time, or convince those that can’t to deliver earlier than they otherwise would, all with an understanding that most will miss the mark. Then again other LPs have made K-1 deadline requests fully expecting GPs to meet their deadlines. Either way, a firm that proactively explains when the K-1 information can reasonably be made available is better than one who does not. And with K-1s being delivered later each year (due in part to more complicated IRS reporting procedures in recent years) that communication strategy is made all the more valuable.   

There’s a middle ground to consider here too. Most firms will make available a draft K-1 report that provides LPs a majority of the fund tax information they need before 15 April. But even a draft K-1 can come late. The tendency among some GPs and their accounting firms might be to wait until the year-end audit report is signed off before commencing the K-1 preparation process. That can be a mistake. According to EisnerAmper tax partner Jay Bakst, the audit is often held up by factors that have no bearing on the K-1s – for example wording in the footnotes or a representation letter – but the numbers needed for tax-related work are often locked-in far before then. Bakst suggests that the key is for the auditors, tax preparers, and GPs to identify that point so that the K-1 process is not unnecessarily delayed.

In the end, a well-executed K-1 delivery is a good mark on your firm’s operations in the eyes of LPs. And the good news is that investors largely understand that filing a tax extension request is the norm as not every GP is capable of meeting April deadlines. But communicating in advance when the K-1 should be expected helps eliminate requests that can be a GP’s very own Mission Impossible.