Standardization and innovation will drive change in the K-1 reporting paradigm

Nate J. Jones

Standardization and innovation will drive change in the K-1 reporting paradigm

At first glance, innovating through standardization can seem like a contradiction in terms. Innovation calls to mind words like newness and cutting edge, while standardization evokes monotony or the mundane. In reality, standardization can play a critical role in developing and implementing innovative new practices.

Schedule K‑1, the tax form used to report individual partners’ share of a partnership’s earnings, losses, deductions, and credits, has been in use for decades. While technology has advanced dramatically since the introduction of K‑1s, the process remains anchored to the constraints of paper-based distribution.

The K‑1 industry is ripe for a paradigm shift – using technology to facilitate a smoother exchange of information between parties. This kind of shift will take collective action and a willingness to reimagine a decades-old process. Standardization will make it possible for constituents on both sides of the K‑1 process to embrace an innovative, new approach.

Steam-powered factories: Reconfiguring to adopt new technology

History is full of examples of innovation and new standards combining to solve problems. One notable example is the electrification of factories in the early 20th century. In the years before electric motors, the predominant way to power a factory was through coal-fired steam. In a steam-powered factory, a single, gigantic steam engine would power a huge, rotating drive shaft. The drive shaft would run the length of the factory, and all the machines were hooked up to it.^{1, 2}

The steam-powered factory was a marvel of its time, but it had its drawbacks. The factory could run no faster than the drive shaft could spin, so no single worker could work ahead of the steam engine’s pace. To power even a single machine along the drive shaft, the entire steam engine had to be powered and running.

When electric motors came around, the technology came with the promise of greater productivity and efficiency at a lower cost. But there was a hitch: Factories had to be completely reconfigured to enjoy the advantages of adopting electricity. The few factory owners who replaced their steam-powered machines early on but retained the legacy configuration, found that their production output barely changed, and their cost savings were nominal.

The real benefit to electric power for factories was that they no longer were dependent on a single steam engine and rotating drive shaft. The entire operating model of factories could be more efficient, with multiple parallel production lines and the ability to run individual machines in isolation. Workers had the autonomy to produce at their own pace, and they could be paid more for greater productivity.

In order to completely realize the benefits of the new technology of the electric motor, however, factories had to reimagine their entire operations. That’s why it wasn’t until the early 20th century that factory owners broadly began to transition to electric motors, even though electric motors first appeared around 30 years prior.

Echoes in the K‑1 process

The way we prepare and distribute K‑1s today has deep parallels to factories transitioning from steam to electric power. The way K‑1s are created and distributed today remains largely the same as it was 30 years ago.

Thirty years ago, we gathered information, determined the correct figures to put on a K‑1, printed a K‑1 containing those figures, and mailed it to the recipient. Today, we gather information, determine the correct figures to put on a K‑1, print that K‑1 to PDF, and post it online for the recipient to download. Like the steam engine and its single drive shaft, paper is the limiting factor of the K‑1 process.

Technology has changed by leaps and bounds over the past 30 years, but the way we prepare and communicate K‑1s has barely budged. Why is that?

We have fallen into the same patterns as steam factory owners. We replaced our old workflow process with computerized versions of the same legacy process. And just as for the steam factory owners adopting electricity without reconfiguration, merely changing the technology that powers the same workflow hasn’t effected much change. The limitations of paper continue to constrain us today.

Reimagining K‑1s for the future

In order to fully realize the innovation enabled by the technology of the digital age, we need to completely reimagine how K‑1s can be created and communicated. The complexity of the data reported on K‑1s requires new, digital standards for preparing, communicating, and managing K‑1 information.

Skeptics might assert that the degree of variation in K‑1 reporting makes the implementation of standards impossible. The fact is, the tax industry is built on standards: We all need to comply with the same tax codes, fill out the same tax compliance forms, complete standard working papers, and provide a consistent K‑1 package year after year.

Common structures can be put in place to facilitate managing all the data needed to create and communicate a K‑1. As we move further into the digital age, reconfiguring the K‑1 process to break free of the constraints of paper distribution will bring the same types of gains in efficiency and productivity ushered in by electricity in factories more than a century ago.

¹ Tim Harford, “Why Didn't Electricity Immediately Change Manufacturing?” BBC, Aug. 21, 2017, https://www.bbc.com/news/business-40673694

² Richard B. Du Boff, “The Introduction of Electric Power in American Manufacturing,” The Economic History Review, vol. 20, no. 3, pp. 509-518, December 1967, www.jstor.org/stable/2593069