Schedule K-1 for VCs

[ BACKGROUND COLOR BLOCK-1 ]

• A Schedule K-1 (often referred to simply as a “K-1”) is a tax document that helps investors in venture funds calculate their tax obligation for the year.
• A venture fund sends K-1s out yearly to all investors—including the general partner and limited partners.
• K-1s are necessary because most venture funds are “pass-through” entities, meaning they pass profits and losses to their investors.
• Funds calculate investors’ income and losses based on each investor’s ownership stake in the fund and the details of their partnership agreement.
• K-1s generally include information about interest income, dividends, and short- and long-term capital gains.
  

[ /BACKGROUND COLOR BLOCK-1 ]

Just like all investment returns, income from successful venture investments is taxable. Every year, a venture fund issues its investors Schedule K-1s to help them calculate their tax liabilities.

All venture investors should understand how to interpret and use a Schedule K-1, given they’ll likely receive a new one every tax season. In this guide, we’ll break down Schedule K-1s for both general partners and limited partners, including what they are, how they work, and how to read them.

What is a Schedule K-1?

A Schedule K-1 is an IRS tax form that reports the gains, losses, interest, dividends, and other distributions of a business or financial entity’s partners from the previous tax year. 

Because most venture funds are set up as limited liability partnerships—with a general partner (GP) running the fund and investors serving as limited partners (LPs)—all investors are considered partners of the fund. The investor receives a Schedule K-1 any year the fund records income or loss, both of which are considered taxable events.

The fund’s investors (both GPs and LPs) use the document to calculate their tax liability when they file taxes.

The partnership agreement an investor signs when investing in a venture fund dictates their share of assets, liabilities, and cumulative income/losses of the partnership—often referred to as the investor’s “capital account” in the partnership.

What Does a Schedule K-1 Include?

A Schedule K-1 includes the following information: 

• Information about the partnership, including name, address, and EIN (if applicable);
• Information about the partner receiving the Schedule K-1, including their name, address, and social security number; 
• The partner’s sharing percentage of profits, losses, and capital at the beginning and end of the tax year in question;
• The partner’s share of liabilities;
• The partner’s share of income, deductions, credits, and other items; and
• Miscellaneous information that a partner needs in order to report their income and loss correctly, but that does not have a designated place on the Schedule K-1.
  

The most common types of income an investor in a venture capital fund will see on their Schedule K-1 are:

• Line 5 (Interest income). An investor will earn interest if the fund has earned interest from the issuance of convertible notes over the previous tax year. 
• Line 6 (Dividends). The K-1 will report a dividend if the fund issued a distribution over the previous tax year. 
• Line 8 & 9 (Short-/long-term capital gains). If the fund exited an investment over the previous tax year, the K-1 will report income/losses generated from the exit as short or long-term capital gains, depending on how long the fund held its position.
• Line 13 (Other deductions). This may include management fees, legal and accounting fees, and due diligence costs. 

GP K-1 vs. LP K-1

While both GPs and LPs are considered partners in the fund, the Schedule K-1 received by the fund manager and the limited partners in the fund will have a few marked differences. These differences reflect the different types of income a fund manager can earn from operating a venture fund.

For LPs in a venture fund, Schedule K-1 income is primarily investment income on lines 5, 6, and 11, as well as capital gains and losses on lines 8 and 9. GPs may see two additional income items on their Schedule K-1.

Management Fees

The fund management fee is an annual fee paid to the fund manager to cover fund operational costs and compensate the fund manager for their work. The partners in the fund cover the cost of the management fee, which usually ranges from 2% to 2.5% of committed capital.

A fund manager receiving management fees will see that income reflected on Line 4 (guaranteed payments) and Line 14 (Self-Employment Income) on their K-1. 

Carried Interest

Carried interest represents the percentage of profits paid to the fund manager in the event of distribution after an agreed-upon threshold of return has been reached for the fund's partners.

For tax purposes, carried interest is considered a reallocation of partnership income from LPs to the carry recipient—meaning it retains the character (and line assignment) as the income received by the LPs. In most cases, it will appear on lines 8 and 9 (short-/long-term capital gains).

To qualify for the long-term capital gains tax rate, the fund manager must hold the assets generating the carried interest for a minimum of three years. LPs in a fund have a holding period of only one year to reach the long-term capital gains tax rate.

Carried interest can also sometimes appear on lines 5 (interest income) and 6 (dividends).

When Do Venture Funds Distribute K-1s?

Venture funds typically must file Schedule K-1s by March 15th, and investors can expect to receive them by mid-summer—though funds can file for a six-month extension.

Once they’ve received their Schedule K-1, investors then use the information to figure out how much of their income is taxable and how much tax they owe on their income tax return (Form 1040).

If a Schedule K-1 arrives late, an investor might need to estimate their tax liability on their own and determine if they need to amend their return once they receive their K-1.

In such cases, an investor should consult with a US tax advisor to determine what solution is best for their facts and circumstances.

Why Do VCs Get a Schedule K-1?

Investors in venture funds get a Schedule K-1 because most venture capital funds are structured as partnerships, meaning they don’t pay corporate income tax. Instead, funds “pass through” profits and losses to their partners proportional to the partner's ownership stake in the fund.

Investors are then responsible for any tax implications of income or losses reported on their Schedule K-1.

Along with issuing K-1s, the fund itself would need to file Form 1065, Return of Partnership Income, to document its income and expenses.

How are Schedule K-1 Calculations Determined?

Schedule K-1 requires a venture fund to calculate each individual investor’s share of the fund’s gains or losses for the year. This helps the investor determine their tax liability since a fund’s gains and losses get “passed through” to them.

An investor’s share of fund profits and losses can be heavily influenced by specific provisions in their partnership agreement—so it’s important for investors to understand their agreements and how it might impact what gets reported on their K-1.

Also, keep in mind that a fund might have different arrangements with different investors that impact their tax liability.

If not specifically addressed in the agreement, income and loss are allocated based on the partner’s capital account.

The capital account formula looks like this:

Capital account = capital contributed + cumulative share of partnership profits - cumulative share of partnership losses - distributions received

Paying Taxes From a Schedule K-1

When an investor receives a distribution from the venture fund, they don’t report and pay tax on that distribution. Instead, they report the income from their Schedule K-1 and pay tax on that.

If the distribution is more than the income reported on the K-1, it’s typically considered a return on the original investment and taxed as capital gains after the fund closes.

Often, though, an investor must report income from their K-1 even though they haven’t seen a distribution yet. This happens when a fund reports income during the year (for example, a portfolio company exits) but has not yet distributed profits to its investors. A fund might wait for all of its positions to close (which can take 10+ years) before issuing returns. Nonetheless, the partner must report their share of the fund’s income as the fund earns it.

When a fund closes, investors will usually incur a gain or a loss—so it’s important that they keep track and plan for any tax liability.

Schedule K-1s on AngelList

AngelList prepares and distributes Schedule K-1s for all platform investors. 

Note that while we’ve provided a basic overview of Schedule K-1s in this article, the U.S. tax code is extensive and many nuances of the rules and regulations have not been addressed here. Some items of income and loss may require more detail than is available on the Schedule K-1 itself, and will necessitate a “footnote” or statement detail that can be attached to the Schedule K-1. 

For more information on those rules as well as other reporting details, visit our Help Center. 

—

AngelList is not a tax advisor. Specific circumstances related to Schedule K-1 should be directed to a professional tax advisor.