After months of expressed concerns from both taxpayers and tax professionals over the Schedule K reporting requirements, the IRS has finally provided some much needed clarity. On February 16, 2022, the IRS released details on transition relief for certain domestic partnerships and S corporations preparing the new schedules K-2 and K-3. This means those eligible for the relief would not have to file until tax year 2022.
According to the IRS, the goal of the new schedules was to create greater clarity in the reporting process by helping partners and shareholders report items of international tax relevance in a clear and standardized format. In addition, the changes ease flow-through return preparation compliance by clarifying obligations and standardizing the format for reporting.
Back in early June 2021, the IRS finalized the release of two new schedules for international pass-through entity tax returns. The first, the Schedule K-2, an extension of Schedule K, is used to report any items of international tax relevance from the operation of a partnership or S corporation. The second, the Schedule K-3, is an extension of Schedule K-1, and is used to report a partner or shareholder’s share of items reported on Schedule K-1.
To qualify for this exception, the following qualifications must be met:
Tax Year 2021:
- Direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates or foreign trusts
- 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
- Domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting such information
Tax Year 2020:
- 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).
It is important to note that even though a partnership or S Corporation may have no foreign members/shareholders, doesn’t own any foreign assets or does not derive any foreign activity, they may still be required to file Forms K-2 and K-3. These forms would be required if a member/shareholder needs relevant information to complete their individual international reporting, such as a foreign income tax credit.
According to the IRS, “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.”
Though the purpose of these schedules was to reduce reporting inconsistencies and unnecessary inquiries and examinations, another year to properly prepare is surely appreciated by those who now qualify for the exception.
Please do not hesitate to reach out to a member of our tax team or your tax advisor for further consultation regarding your situation.