Draft 2022 partnership K-2 and K-3 instructions provide domestic filing exception

Since early 2022, tax pros have argued that they should not have to file Form 1065 K-2 and K-3, especially for businesses with no foreign activity and no foreign owners.  

On October 25, 2022, the IRS issued a draft set of instructions for a partnership’s 2022 Schedule K-2s and K-3s. In these draft instructions, the IRS responded to their calls for expanded relief and clarity by adding a new “Domestic filing exception” for partnerships in draft instructions for the 2022 tax year schedules K-2 and K-3. 

Under the instructions, partnerships do not have to file these two schedules if the four criteria and the notification dates described below are met.

Who must file 2022 schedules K-2 and K-3? 

First, the general rule is that all partnerships must file Schedules K-2 and K-3 unless the partnership meets an express exception.  

However, the draft instructions create a “Domestic filing” exception. It provides that a domestic partnership doesn’t need to complete and file the schedules or furnish the schedules to a partner if the partnership meets four criteria and specific date requirements for a partnership’s tax year 2022.

1. No or limited foreign activity

The domestic partnership does not have foreign activity, or if it does, the activity is very limited. The instructions provide a detailed definition of what constitutes permissible “foreign activity.” This limited, or “de minimis,” exception is a key change from last year. Essentially, the partnership is permitted to have a minor amount of foreign taxes withheld on stocks, mutual funds, etc. 

2. U.S. Citizen/resident alien partners

During the 2022 tax year, all direct partners must be one of the following: 

• U.S. citizens
• Resident aliens
• Domestic decedent’s estate 
• Domestic grantor trust 
• Domestic non-grantor trust 

3. Partner notification

Assuming a partnership meets the first two criteria, a notification must be sent to all partners –electronically or by mail – dated no later than two months before the due date without extension for filing the partnership’s 2022 Form 1065. The 2023 deadline for filing the partnership’s 2022 Form 1065 – without extension – is January 15, 2023. 

The notification must state the partners will not receive Schedule K-3 from the partnership unless the partners request the schedule.

4. No 2022 Schedule K-3 requests by the 1-month date 

The partnership must not receive a request from any partner for a Schedule K-3 on or before one month before the due date (without extension) of the partnership’s Form 1065. For the tax year 2022, calendar-year partnerships have a one-month date of February 15, 2023.  

However, if a partner fails to request the Schedule K-3 by February 15, she/he can still request it after that date, and the partnership is required to provide the requested information to that partner. 

Under these draft instructions, if a partnership misses the January 15, 2023, date to notify the partners, it would be required to prepare and file the 2022 Schedules K-2 and K-3 with Form 1065.

Keep in mind

These instructions are draft in nature. They are subject to change. 

These draft instructions cover partnerships…NOT S Corporations or their shareholders, Form 1120-S Schedules K-2 and K-3. We expect the S Corporation K-2 and K-3 instructions to be issued soon and generally should follow those issued for partnerships and partners.