The insights in this article are powered by CCH AnswerConnect, Wolters Kluwer's industry-leading tax research solution. As such, some of the links included in this article lead to subscriber-only CCH AnswerConnect content. For access to these insights, log in or sign up for a complimentary trial.
Once again, partnerships and S corporations may need to file Schedules K-2 and K-3 with the returns they file in 2024 for tax years beginning in 2023.
Partnerships and S corporations with “items of international tax relevance” must file the schedules. A partnership files the schedules with its Form 1065. An S corporation files the schedules with its Form 1120-S. The partnership or S corporation must also give Schedule K-3 to its partners or shareholders.
The IRS has released draft instructions for the 2023 Schedules K-2 and K-3. The draft instructions keep the “domestic filing exception” introduced in 2022. They also make a few changes to the schedules and instructions for 2023.
Schedules retain the domestic filing exception
Under the domestic filing exception, a domestic partnership or S corporation will not need to file Schedules K-2 and K-3 for tax year 2023 if the partnership—
- Had no foreign activity, or limited foreign activity;
- Notifies its partners or shareholders that they will not receive Schedules K-3 unless they request them; and
- Does not receive a request from a partner or shareholder for Schedule K-3.
- In addition to those three requirements, a partnership must have only U.S. citizens and/or resident aliens as partners.
More specifically—
A partnership or S corporation had foreign activity if it paid or accrued foreign income taxes; had foreign-source income or loss; or owned a foreign partnership, foreign corporation, foreign branch, or foreign disregarded entity. But the partnership or S corporation can still meet the first requirement if it had only “limited” foreign activity—meaning it had only passive-category foreign income on which it paid or accrued no more than $300 of creditable foreign taxes (provided the income was shown on a payee statement given to the partnership or S corporation).
The partnership or S corporation meets the second requirement if it lets its partners or shareholders know, no later than the date on which it gives them their Schedules K-1, that they will not receive Schedules K-3 unless they ask for them.
And the partnership or S corporation satisfies the third requirement for the domestic filing exception if no partner or shareholder makes such a request by the date that is one month before the date on which the partnership or S corporation files its Form 1065 or 1120-S. So, for calendar-year partnerships or S corporations that file extensions, the latest date for the partnership or corporation to receive a request is August 15, 2024.
The partnership meets the special, fourth requirement for the domestic filing exception if it had no partners during the tax year other than individual U.S. citizens, resident aliens, domestic decedents’ estates with only U.S. citizens or resident aliens as beneficiaries, domestic trusts with only U.S. citizens or resident aliens as grantors and beneficiaries; single-shareholder S corporations; and single-member limited liability companies that are disregarded entities and whose sole member is one of those parties listed above.
The 2023 draft instructions add one feature to the domestic filing exception for both partnerships and S corporations: if a partner or shareholder made a request for Schedule K-3 for tax year 2022, the partner or shareholder is treated as having made a request for tax year 2023 as well. Otherwise, the domestic filing exception is the same for 2023 as it was for 2022.
Draft instructions for partnerships add several new features for 2023
For 2022, a partnership checked box 7 on Part I of Schedules K-2 and K-3 if the partnership had Form 8858 information, but on the 2023 schedules box 7 is reserved for future use. The draft instructions for the 2023 schedules say that in some cases box 13 now asks for information that a partner needs for the partner’s Form 8858.
The 2023 draft instructions also state that some partnerships must now report information about dual consolidated losses with Schedules K-2 and K-3. If they do need to report those losses, they should check box 11 in Part I of the schedules.
IRS Revenue Procedure 2022-43 contains a “qualified intermediary agreement” that withholding agents should use when they need to deduct, withhold, and pay tax on income paid to a foreign person. The agreement applies beginning on January 1, 2023. Qualified intermediaries include qualified derivatives dealers, and the 2023 draft instructions tell a partnership that is a qualified derivatives dealer to file Form 1065 and attach a statement with the information required in section 7.01(C) of the agreement. However, the draft instructions also say that if a partnership is filing Form 1065 solely because it is a qualified derivatives dealer, it does not need to file Schedules K-2 and K-3.
The draft instructions for the schedules say that amounts may now be entered in lines 41 through 43, columns (a) through (e), of Part II.
Part VIII of Schedules K-2 and K-3 continues to request information about the partnership’s interest in controlled foreign corporations. Part VIII of the 2023 schedules contains two new columns (for a foreign corporation’s total net income, and for the foreign corporation’s current-year foreign taxes for which a credit is allowed). Part VIII also now asks for the foreign corporation’s functional currency.
Finally, new lines have been added to Part XIII of Schedule K-3 to provide additional information that a nonresident alien, foreign trust, or foreign estate may need when it completes Schedule P of Form 1040-NR to report information and calculate gain or loss on the transfer of an interest in a partnership engaged in the conduct of a trade or business within the United States. Part XIII exists only on Schedule K-3; Schedule K-2 has no Part XIII.
Draft instructions for S corporations add one new feature for 2023
The 2023 draft instructions for the S corporation schedules say that Part VII of Schedules K-2 and K-3 for Form 1120-S continues to request information about an S corporation’s interest in controlled foreign corporations. Part VII of the 2023 schedules contains two new columns (for a foreign corporation’s total net income, and for the foreign corporation’s current-year foreign taxes for which a credit is allowed). Part VII also now asks for the foreign corporation’s functional currency.
Otherwise, the schedules for S corporations are the same in 2023 as they were in 2022.
