Introducing Schedules K-2 and K-3

Partnerships, S corporations, and U.S. persons with interests in foreign partnerships may be required to file Schedules K-2 and K-3 with the returns they file in 2022 for tax years beginning in 2021.  Partners and shareholders of these pass-through entities will use this information to complete their respective tax returns.

The IRS recently released new requirements for enhanced reporting of international tax matters by pass-through entities.  Many international tax rules were altered and expanded by The Tax Cuts and Jobs Act. That act requires that partnerships provide additional information to certain partners with regard to international tax attributes such as GILTI, BEAT, and FDII.

According to the Internal Revenue Service, “these schedules are intended to provide greater clarity for partners and shareholders on how to compute their U.S. income tax liability with respect to items of international tax relevance, including claiming deductions and credits.”

WHICH FORMS ARE AFFECTED?

Schedules K-2 and K-3 are being added to the filing requirements for three forms – Form 1065, Form 1120S and Form 8865

WHY THE NEED FOR SCHEDULES K-2 AND K-3?

The current K-1 schedules provided by flow through entities do not provide partners with enough information to comply with their U.S. filing requirements. Currently, international tax items are normally reported as a footnote or statement attached to the  K-1 package. This results in the partners receiving various amounts of detail in respect of international tax-related items.  Many need to chase after all the information required to comply with the new international tax provisions on their returns.
 
The new Schedules K-2 and K-3 will help pass-through entities provide partners and shareholders with information necessary to complete their own tax returns.   Information that may have once been included in footnotes or statements attached to a Schedule K-1 will now be much clearer and in a standardized format. This will make it easier for preparers and investors to prepare the returns.  

WHEN ARE SCHEDULES K-2 AND K-3 REQUIRED?

The new schedules K-2 and K-3 must be filed by all pass-through entities with items of international tax importance, including foreign partners and international activities.

However, an entity with no foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3. For example, if a partner claims a credit for foreign taxes paid by the partner, the partner may need certain information from the partnership to complete Form 1116. Also, a partnership that has only domestic partners may still be required to complete Part IX when the partnership makes certain deductible payments to foreign related parties of its domestic partners. The information reported in Part IX will assist any domestic corporate partner in determining the amount of base erosion payments made through the partnership, and in determining if the partners are subject to the Base Erosion and Anti-Abuse Tax. 

UPDATE: The IRS intends to provide certain additional transition relief for this year from the Schedule K-2 and K-3 reporting for certain domestic partnerships and S corporations with no foreign activities, foreign partners or shareholders, and without knowledge of partner or shareholder need for information on items of international relevance. For 2021, these qualifying domestic partnerships and S corporations will not have to file the new schedules if the following applies:

  • In tax year 2021, the direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts. 
  • In tax year 2021, the domestic partnership or S corporation has no foreign activity, including foreign taxes paid or accrued or ownership of assets that generate, have generated, or may reasonably expected to generate foreign source income
  • In tax year 2020, the domestic partnership or S corporation did not provide to its partners or shareholders nor did the partners or shareholders request the information regarding (on the form or attachments thereto):
    • Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S), and
    • Line 20c, Form 1065, Schedules K and K-1 (Controlled Foreign Corporations, Passive Foreign Investment Companies, 1120-F, section 250, section 864(c)(8), section 721(c) partnerships, and section 7874) (line 17d for Form 1120-S).
  • The domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting such information for tax year 2021.

If a partnership or S corporation qualifies for this exception, the domestic partnership or S corporation does not need to file Schedules K-2 and K-3 with the IRS or with its partners or shareholders.  However, if the partnership or S corporation is subsequently notified by a partner or shareholder that all or part of the information contained on Schedule K-3 is needed to complete their tax return, then the partnership or S corporation must provide the information to the partner or shareholder.  If a partner or shareholder notifies the partnership or S corporation before the partnership or S corporation files its return, the conditions for the exception are not met and the partnership or S corporation must provide the Schedule K-3 to the partner or shareholder and file the Schedules K-2 and K-3 with the IRS.

PENALTIES

Penalties may apply for failing to timely file correct Schedules K-2 or for failing to timely furnish correct Schedules K-3 to partners./shareholders. A return will not be considered complete if the Schedules K-2 is not attached to the return or Schedules K-3 are not provided to the partners/shareholders. 

The IRS recognized that the implementation of new Schedules K-2 and K-3 will create challenges to taxpayer.  As a result, the IRS issued Notice 2021-39 which provides transition relief.  For tax years that begin in 2021, certain penalties will not be imposed for incorrect or incomplete reporting on Schedule K-2 or K-3 if the filer establishes to the satisfaction of the IRS that it made a good-faith effort to comply with the new reporting requirements.

LEARN MORE ABOUT SCHEDULES K-2 AND K-3

PTIN Courses International has developed a course that discusses when the Forms K-2 and K-3 are required to be filed as well as general instructions on how to complete the forms.

Upon completion of this course, participants will be able to:

  • Understand the purpose of Schedule K-2 and K-3
  • Identify when Schedules K-2 and K-3 are required to be filed
  • Complete Schedule K-2 and K-3
  • Apply for penalty relief for 2022 filings

PTIN Courses International is an IRS-approved CE Provider.

We offer a quality continuing education experience for a reasonable price of $10.00 per credit hour!! Please take a look at the courses we currently have to offer by visiting our “All Courses” page. We are so excited to become a part of your professional journey.

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