Last year, the IRS released new forms and filing requirements for any business with international activities via the introduction of Schedule K-2 and Schedule K-3. Schedule K-2 reports items of international tax relevance while Schedule K-3 reports a partner’s distributive share of items of international tax relevance. As part of a provision in the Tax Cuts and Jobs Act (TCJA), these requirements are designed to provide more consistency and transparency for both the IRS and business partners related to international information.
K-2 and K-3 2021 Review
The new schedule filing requirements apply to passthrough entities (1120-S filers) as well as separate business entities (Form 1065 filers). However, the language in the original regulations had such a wide reach that tax practitioners expressed concerns. In response to some of these concerns, in February of 2022, the IRS provided “transition relief” allowing most passthrough entities the option to not file forms K-2 and K-3 for the 2021 tax filing season.
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 be expected to generate foreign-source income (see Regs. Sec. 1.861-9(g)(3)).
In tax year 2020, the domestic partnership or S-corp did not provide to its partners or shareholders, nor did the partners or shareholders request, the information on the form or its attachments regarding:
- 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, Sec. 250, Sec. 864(c)(8), Sec. 721(c) partnerships, and Sec. 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.
In addition to limiting who was required to file last year, the IRS also provided leniency to some penalties if business owners and tax practitioners made a “good-faith effort” to comply with the new K-2 and K-3 filings. (For example, if you did not file the forms – or they were filed incorrectly – but you had proof that you tried to collect the necessary information from partners, to no avail.) With a year under our belts though, 2023 is going to look a little different. However, for 2022 filings, the IRS has responded to tax practitioners’ argument that if a business has no foreign activity, it should be excluded from the K-2 and K-3 requirements by providing a “Domestic Filing Exception” option for partnerships.
2022: Domestic Filing Exception
In the final instructions for the Schedules K-2 and K-3 for the 2022 tax year, the IRS added an important exception to the requirements for filing Schedules K-2 and K-3 with respect to domestic filing (domestic filing exception) for both partnerships and S corporations. Under the exception, a domestic partnership is not required to complete and file Schedules K-2 and K-3, or provide Schedule K-3 to its partners (except if requested to by a partner, as further described below), if each of the below four criteria are met for the tax year:
The partnership had no foreign activity – or has foreign activity that is limited to passive income generating no more than $300 of foreign taxes that are eligible for foreign tax credit.
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 be expected to generate foreign-source income (see Regs. Sec. 1.861-9(g)(3)).
The partners must receive a notification from the partnership stating they will not receive Schedule K-3 from the partnership unless the partners request the schedule. This notification must be furnished at the latest when the partnership furnishes the Schedule K-1 to the partners; and
The partnership must not receive a request from any partner for Schedule K-3 information on or before a date that is one month before the date the partnership files the Form 1065 (the one-month date).
For tax year 2022 calendar year partnerships, the latest one-month date is August 15, 2023, if the partnership files an extension.
If a Partner Makes a Request
If a partnership receives a request from a partner for the Schedule K-3 information after the one-month date, the partnership will still be required to provide the Schedule. (This holds true even if the domestic filing exception is met and the partnership is not required to file the tax year 2022 Schedules K-2 and K-3 with the IRS.) In this situation, the partnership does not have to furnish the tax year 2022 Schedule K-3 to the non-requesting partners.
The schedule must include the requested information and be provided on the date the partnership files the Form 1065 or one month from the date on which the partnership receives the request from the partner. Additionally, the partnership must complete and file tax year 2023 Schedules K-2 and K-3 with respect to the requesting partner by the tax year 2023 Form 1065 filing deadline.
These same general rules apply for S corporations and their shareholders. If you have questions, please reach out to our team.
Chris VanArsdale
Chris is a Strategic Analyst who maintains expertise in litigation support, international taxation, and complex entity and fiduciary taxation services.
