Schedules K-2 and K-3 partnerships S corporations
Tax & AccountingNovember 12, 2021

New Schedules K-2 and K-3: What Partnerships and S Corporations Can Expect in the First Year of Reporting

By: CCH AnswerConnect Editorial

Partnerships, S corporations, and U.S. persons with interests in foreign partnerships may have to file Schedules K-2 and K-3 with the returns they file in 2022 for tax years beginning in 2021. Specifically:

  • S corporations with “items of international tax relevance” must file Schedule K-2, Shareholders’ Distributive Share Items—International; and Schedule K-3, Shareholder’s Share of Income, Deductions, Credits, etc.—International.
  • Partnerships with “items of international tax relevance” must file Schedule K-2, Partners’ Distributive Share Items—International; and Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc.—International.

An S corporation files the schedules with its Form 1120-S. A partnership files the schedules with its Form 1065 or Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. The S corporation or partnership must also provide Schedule K-3 to its shareholders or partners. However, the IRS may waive penalties for filers that fail to comply with the new rules.

Who Must File Schedules K-2 and K-3?

The new schedules must be filed by all pass-through entities with items of international tax relevance, including foreign partners and international activities. However, pass-through entities with no international tax items to report do not have to file the schedules.

Items of international tax relevance include information partners and shareholders need to determine their:

  1. foreign tax credits (income or loss by source and separate category of income);
  2. IRC §250 deduction with respect to foreign-derived intangible income (FDII);
  3. inclusions of subpart F income and Global Intangible Low-Taxed Income (GILTI); and
  4. distributions from a foreign corporation that are treated as dividends or excluded from gross income because they are attributable to previously taxed earnings and profits (PTEP).

Purpose of New Schedules K-2 and K-3

The new Schedule K-2 and Schedule K-3 replace and supplement the reporting of items that were previously reported (often in less detail) on Schedules K and K-1. The new schedules:

  • standardize the format and methods for the international reporting for pass-through entities;
  • help pass-through entities provide partners and shareholders with information necessary to complete their own tax returns;
  • provide clarity to partners and shareholders preparing their returns; and
  • allow the IRS to better assess compliance.

Transition Period Penalty Relief for Schedules K-2 and K-3

The IRS acknowledges that reporting and compliance challenges may arise when filing the Schedules K-2 and K-3. For example, filers may not have systems or procedures in place to obtain the detailed information required to determine whether and how they must file a part of the new schedules.

Thus, for tax years beginning in 2021 (returns filed in 2022), penalties will not be imposed for incorrect or incomplete reporting on Schedules K-2 and K-3, if the partnership or S corporation establishes that it made a good faith effort to comply with the requirements to file or furnish the schedules.

Good Faith Efforts to Comply

When determining whether an entity made a good faith effort to comply with the Schedule K-2 and K-3 requirements, the IRS will consider the extent to which the filer:

  1. changed its systems, processes, and procedures for collecting and processing relevant information;
  2. obtained information from partners, shareholders, or a controlled foreign partnership (CFP), or applied reasonable assumptions when information is not obtained; and
  3. took steps to modify the partnership or S corporation agreement or governing instrument to facilitate the sharing of information with partners and shareholders that is relevant to determining whether and how to file Schedules K-2 and K-3.

The IRS will also evaluate the entity’s efforts to obtain relevant information about partners, shareholders, or CFPs. Given the wide variety of relationships that exist between Schedule K-2/K-3 filers and partners/shareholders, the entity might fail to obtain the required information despite its good faith efforts to do so.

CCH AnswerConnect Editorial

Comprising of industry’s most trusted experts, the Wolters Kluwer CCH AnswerConnect Editorial Staff are knowledgeable and highly qualified to analyze and offer guidance on the latest, important tax topics. They ensure every topic is thoroughly researched and meticulously broken down so you receive the most up to date and accurate information available. Read more of their insights on CCH AnswerConnect.

Solutions for Tax & Accounting Professionals

Tax, accounting, workflow, and firm management solutions to help your firm succeed, with the research tools you need to stay informed.

 

Back To Top