How Do K-1 Taxes Work? A Guide for High-Income W-2 Families

By Kevin Luu, Co-Founder and Chief Learning Officer. Reviewed on 2026-09-30.

A Schedule K-1 reports your share of the income, gains, losses and deductions of a partnership, S corporation, trust or estate, and you owe tax on that share on your own Form 1040 whether or not you received any cash. You do not attach the K-1 to your return. You copy its numbers onto the right schedules (mostly Schedule E, plus Schedule B and Schedule D), and they flow into your adjusted gross income like any other income.

For a W-2 household earning $750,000 to $3 million in California or Washington, K-1s usually arrive once you start investing beyond a brokerage account: a venture or private equity fund through work or an angel group, a real estate syndication, a physician group organized as a partnership, or a family LLC or trust set up for the kids. This guide covers how the tax works, a worked example at that income level, and the decisions that actually matter.

Where K-1s come from, and which form you are holding

There are three versions, and the header tells you which one you have.

The IRS partner instructions say it plainly: keep the K-1 for your records and do not file it with your return unless specifically required (IRS Partner’s Instructions for Schedule K-1 (Form 1065)). The entity sends its own copy to the IRS, which matches it against your return. For line-by-line detail, see where K-1 income goes on the 1040.

How K-1 income is taxed on a Form 1040

A partnership or S corporation generally pays no federal income tax itself. It passes each item through to the owners, and each item keeps its character. That is why a K-1 has so many boxes: interest is taxed as interest, qualified dividends and long-term gains at capital gains rates, and ordinary business income at your ordinary rate.

• You are taxed on allocations, not distributions. The IRS instructions say you may be liable for tax on your share of partnership income “whether or not distributed.” A fund that sells a company and reinvests the proceeds can hand you a tax bill with no cash attached.
• Passive losses usually cannot offset W-2 pay. Losses from an activity you do not materially participate in are passive, and you use Form 8582 to work out how much you can deduct (IRS Publication 925). The $25,000 rental real estate allowance is reduced by 50% of modified AGI over $100,000 and is generally unavailable at $150,000 or more, so it is gone at this income level. Unused losses carry forward.
• Portfolio income is not passive income. Interest, dividends and capital gains from a fund are portfolio income under Publication 925, so a real estate loss cannot soak up the gain from a venture fund.
• The 3.8% Net Investment Income Tax usually applies to fund and passive K-1 income. For 2026 it hits the lesser of net investment income or MAGI above $250,000 for joint filers (IRS NIIT page). Every household in our reader’s range is above that threshold. Business income from a partnership you actively work in, such as a medical group, is generally not net investment income.

K-1 income is not wages. Whether any of it counts as earned income (for example, for an IRA contribution) depends on the entity and your role, covered in does K-1 income count as earned income.

Worked example: a $1.1 million California household with two K-1s

Assumptions (illustrative): married filing jointly in San Mateo County, $1,100,000 of W-2 income from a biotech job and a physician salary, taxable income above $1 million for both federal and California purposes. They hold two private investments.

1. Venture fund K-1 (Form 1065): $40,000 of long-term capital gain allocated after the fund sold a portfolio company. The fund kept the cash to make follow-on investments, so no distribution.
2. Real estate syndication K-1 (Form 1065): an $18,000 loss, mostly depreciation, plus a $12,000 cash distribution.

Federal tax on the venture gain, 2026: taxable income is above $613,700, so the gain is taxed at 20%, plus 3.8% NIIT. That is 23.8% of $40,000, or $9,520.

California tax on the venture gain: California has no lower rate for capital gains (FTB). Using the 2025 rate schedule (2026 schedules are not yet published), joint taxable income between $891,542 and $1,485,906 sits in the 11.3% bracket, and the 1% Behavioral Health Services Tax applies above $1,000,000 of taxable income. At 12.3% combined, the $40,000 gain adds about $4,920.

Total: roughly $14,440 of tax on income that never reached their bank account.

The real estate loss: with MAGI far above $150,000, the $18,000 passive loss cannot offset their wages, and it cannot offset the venture fund’s capital gain either. It is suspended and carried forward until they have passive income or sell their entire interest. The $12,000 distribution is generally not taxed as income on its own; it reduces their basis in the investment (IRS Publication 541).

Same family in Seattle: the federal $9,520 is unchanged. Washington has no wage income tax in 2026, and its 7% capital gains tax applies only to Washington long-term gains above the standard deduction ($278,000 for 2025, the latest published) (WA DOR). DOR is explicit that individuals can owe it through a pass-through entity that sells long-term capital assets, while gains attributable to real estate are exempt. So the $40,000 alone would not trigger it, but a large fund exit on top of stock sales could. From 2028, Washington adds a 9.9% income tax on AGI over $1,000,000 (WA DOR income tax), which would reach this family’s income level.

Timing: why K-1 families often extend their 1040

A partnership must give K-1s by its own return due date, which is March 15 for a calendar-year partnership, and later if it extends (Form 1065 instructions). Funds extend often, so a K-1 can arrive after April 15. See when to expect your K-1.

An extension on Form 4868 gives you more time to file, not more time to pay (IRS Form 4868). The practical fix is to pay enough during the year. Under IRS Publication 505, you generally avoid an underpayment penalty by paying 90% of this year’s tax or 110% of last year’s tax when last year’s AGI exceeded $150,000. W-2 withholding alone rarely covers K-1 income at a 23.8% federal rate plus California tax, so an estimated payment or a higher W-4 withholding figure is often needed.

The decisions that actually matter

• Before you invest: ask how late the fund’s K-1s typically arrive, whether it issues estimates in February or March, and which states it will file in. Each answer changes your filing calendar and your preparer’s bill.
• Cash for taxes: set aside about 36% of expected allocated long-term gains (23.8% federal plus 12.3% California at the example family’s brackets; 13.3% in California’s top bracket) even when no distribution is expected. Washington families can plan closer to the federal rate until their gains approach the state threshold.
• Real estate losses: buy a syndication for its economics, not for its losses. At this income, those losses usually sit suspended for years.
• Corrections: if a K-1 is wrong, ask the issuer for a corrected one. If you report an item differently from the K-1, the IRS requires Form 8082 with your return.

How the rates compare with a 1099 is covered in K-1 vs 1099 tax rates.

When the kids start receiving K-1s

If you set up a family LLC and give units to your children, or a trust for them distributes income, the children receive K-1s in their own names. Their share of interest, dividends and capital gains is unearned income, so the kiddie tax applies: for 2026 the first $1,350 is tax-free, the next $1,350 is taxed at the child’s rate, and unearned income over $2,700 is taxed at the parents’ rate (IRS Rev. Proc. 2025-32). Beyond the first $2,700, gifting units does not move income into a lower bracket for children the kiddie tax covers. It can still make sense for estate and teaching reasons, which is an estate planning question.

What to write down for your children

Private investments are where kids see the least. A K-1 shows up, a check goes to the IRS, and nobody explains why you bought into the fund, what you expected, or what you would do differently. A one-page note per investment (why you invested, the tax surprise, the lesson) is worth more to a future 25-year-old than the K-1 itself. As Kevin Luu puts it: “Your kids don’t need to inherit your portfolio. They need to inherit your decision-making process.”

Common questions

Do I pay tax on a K-1 if I received no money?

Usually yes. You are taxed on your allocated share of the entity’s income, not on the cash it sends you. A fund can allocate a capital gain and reinvest the proceeds, leaving you with tax due and no distribution. Plan cash for that tax separately, especially in a year a fund reports an exit.

Can a K-1 loss reduce tax on my RSU income?

Generally not if the loss is passive, which is the case for most fund and syndication investments. RSU income is wages. Passive losses can offset passive income, and any unused amount carries forward until you have passive income or dispose of your whole interest in the activity.

Next step

Before filing season, list every private investment that sends a K-1, the date each arrived last year, and the amount of tax it produced. That single table tells your preparer whether to plan an extension and how much to pay in estimates. If you want a second set of eyes, our tax management team reviews this as part of the Tax & Wealth Assessment.

This is general education, and the right move depends on your family’s full picture.

Written by

Kevin Luu

Co-Founder and Chief Learning Officer, Bright Advisers

Kevin has advised high-income W-2 tech and biotech families since 2015, and leads the education-first Age Five Family Office from Brea, California.

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