We have tested K2 with the most popular SEF component in the Joomla! community, sh404SEF, and it works flawlessly. We also work closely with the sh404SEF to quickly adjust any changes to their codebase.
Regarding K2 and Joomla! 1.6... Version 2.5 will bring full support for 1.6. You can test drive the beta version of 2.5 (called SVN) on getk2.org (see link bottom right).
I recommend this to every user that want more visits to your own site.