Schedule K-2 is an extension of Schedule K and is used to report items of international tax relevance from the operation of a partnership or S corporation. Schedule K-3 is an extension of Schedule K-1 and is generally used to report to partners or shareholders their shares of the items reported on Schedule K-2. Partners or shareholders must include the information reported on Schedule K-3 on their tax or information returns, if applicable.
Who Must File
Any partnership or S corporation that has items relevant to the determination of the U.S. tax or certain withholding tax or reporting obligations of its partners or shareholders under the international provisions of the Internal Revenue Code must complete the relevant parts of Schedules K-2 and K-3. See the instructions for each part and section for a more detailed description of who must file. A partnership or S corporation with no foreign source income, no assets generating foreign source income, no foreign partners, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3.
Penalties may apply for filing Form 1065 without all required information or for furnishing Schedules K-3 to partners without all required information. The penalties that apply with respect to Form 1065 and Schedule K-1 apply with respect to Schedules K-2 and K-3, respectively.
Standardized Schedule Format
For tax years beginning in 2021, the IRS released new schedules for pass-through international tax reporting to accommodate the complex provisions enacted under the Tax Cuts and Jobs Act (TCJA). The TCJA required a significant increase in the amount and types of information needed to calculate the U.S. tax liability with respect to items of international tax relevance. The IRS observed in the years following TCJA that items of international tax relevance were not always reported in a clear and standard format.
The revised format was created to provide consistency and eliminate confusion. The new schedules K-2 and K-3 assist pass-through entities in providing partners and shareholders with the information necessary to voluntarily comply with their filing and reporting obligations in an efficient manner. While partnerships and S corporations will initially have transition costs, ultimately they will benefit from increased transparency of information and reduced uncertainty about what to report and how to report it.
The greater certainty also enables the IRS to more quickly verify tax compliance, confirming that partnership and S corporation items are properly reported on partners’ and shareholders’ returns. This improvement should ease the burden on both taxpayers and the IRS by reducing unnecessary inquiries and examinations that may arise due to inconsistent reporting of partnership and S corporation items.
The following standardized forms are required for partnerships with an interest in foreign partnerships:
- Schedule K-2, Partners’ Distributive Share Items – International; and
- Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc. – International
2022 Domestic Filing Exception
For tax years beginning in 2022, the IRS has added a new domestic filing exception for partnerships and S corporations for filing and furnishing Schedules K-2 and K-3.
The filing exception is detailed in the Partnership Instructions for 2022 Schedules K-2 and K-3. Under the exeption, a domestic partnership does not need to (a) complete and file with the IRS the Schedules K-2 and K-3, or (b) furnish to a partner the Schedule K-3 (except if requested by a partner after the 1-month date) if each of the following four criteria are met:
- No or limited foreign activity – During a domestic partnership’s tax year, the domestic partnership either has no foreign activity or if it does have foreign activity, such foreign activity is limited to (a) passive category foreign income; (b) upon which not more than $300 of foreign income taxes allowable as a credit are treated as paid or accrued by the partnership; and (c) such income and taxes are shown on a payee statement that is furnished or treated as furnished to the partnership.
- S. citizen/resident alien partners – During the tax year, all the direct partners in the domestic partnership are: (a) individuals that are U.S. citizens; (b) individuals that are resident aliens; (c) domestic decedent’s estates (that is, decedent’s estates that are not foreign estates), with solely U.S. citizen and/or resident alien individual beneficiaries; (d) domestic grantor trusts that are not foreign trusts and that have solely U.S. citizen and/or resident alien individual grantors and solely U.S. citizen and/or resident alien individual beneficiaries; or (e) domestic non-grantor trusts with solely U.S. citizen and/or resident alien individual beneficiaries.
- Partner notification – With respect to a partnership that satisfies criteria 1 and 2, partners receive a notification from the partnership at the latest when the partnership furnishes the Schedule K-1 to the partner. The notice can be provided as an attachment to the Schedule K-1. The notification must state that partners will not receive Schedule K-3 from the partnership unless the partners request the schedule.
- No 2022 Schedule K-3 requests by the 1-month date – The partnership does not receive a request from any partner for Schedule K-3 information on or before the 1-month date. The “1-month date” is one month before the date the partnership files the Form 1065. For tax year 2022 calendar-year partnerships, the latest 1-month date is August 15, 2023, if the partnership files an extension.
If a partnership receives a request from a partner for the Schedule K-3 information after the 1-month date and has not received a request from any other partner for Schedule K-3 information on or before the 1-month date, the domestic filing exception is met and the partnership is not required to file the Schedules K-2 and K-3 with the IRS or furnish the Schedule K-3 to the non-requesting partners. However, the partnership is required to provide the Schedule K-3, completed with the requested information, to the requesting partner on the later of the date on which the partnership files the Form 1065 or one month from the date on which the partnership receives the request from the partner.
If the partnership received a request from a partner for Schedule K-3 information on or before the 1-month date and, therefore, the partnership does not satisfy criterion 4, the partnership is required to file the Schedules K-2 and K-3 with the IRS and furnish the Schedule K-3 to the requesting partner. The Schedules K-2 and K-3 are required to be completed only with respect to the parts and sections relevant to the requesting partner.
The S Corporation Instructions for 2022 Schedules K-2 and K-3 include a domestic exception to filing K-2 & K-3 similar to the partnership filing exception. One notable difference is that requirement two in the partnership instructions above is not applicable for s corporations.
Final Thoughts
The domestic filing exception, unfortunately, will not extend to partnerships with direct partners who are domestic corporations or domestic partnerships (i.e., tiered partnerships). Therefore, it is likely that the domestic filing exception will apply to fewer domestic partnerships than domestic S corporations. If you have any questions regarding the above information, please reach out to the GYF tax professionals at 412-338-9300 for additional guidance and assistance.
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