New Schedules K-2 and K-3 for Passthrough Entity Tax Returns

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At the tail end of 2021, the Internal Revenue Service (IRS) released new Schedules K-2 and K-3 effective for tax years beginning January 1, 2021. These schedules are designed to present a substantially greater amount of information to the IRS about sources of income (US or foreign) as well as investors in partnerships (US or foreign). Guidance has been changing and may change again, but the new reporting requirement is expected to impact many tax returns, including some without any foreign activity, for tax year 2021.

For the 2021 tax year, if a taxpayer has items of international relevance, they are required to report on new Schedules K-2 and K-3, if they file:

  • Form 1065, U.S. Return of Partnership Income,
  • Form 1120-S, U.S. Income Tax Return for an S Corporation, and
  • Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships

 

Schedule K-2 reports the partnership/S-corporation level activity. The K-2 has up to 11 parts and reports the required U.S. international tax information on a total partnership basis and is filed as part of Forms 1065. Schedule K-3 provided to each partner or shareholder, reports its proportionate amount for each item. It has up to 12 parts and reports each investor’s pro-rata share of items reported on Schedule K-2 and is provided to each investor as part of his/her respective Schedule K-1 packet.

The latest IRS guidance, issued on February 16, 2022, in the form of Frequently Asked Questions (FAQs), explains that, for the 2021 tax year, there is a temporary exception to the filing requirements for partnerships and S-corporations that meet the following criteria:

  • The direct partners in the domestic partnership are neither a foreign entity nor foreign individuals
  • The domestic partnership or S-corporation has no foreign activity
  • 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 information regarding any foreign transactions
  • The domestic partnership or S-corporation has no knowledge that the partners or shareholders are requesting such information for tax year 2021

 

Guidance around these forms is constantly evolving and has faced opposition from practitioners and taxpayers. On February 24, 2022, the AICPA and 52 state CPA societies sent a letter to Assistant Treasury Secretary and IRS Commissioner regarding widespread concerns on the Schedules K-2 and K-3 reporting and asked to delay the implementation of these changes to allow practitioners sufficient time to understand and implement these changes.

We are following the developments closely and will keep you posted.

Please contact your HM&M advisor should you have any questions or would like additional information.

 

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