Alert

On February 16, 2022, the IRS published FAQs related to the new Schedules K-2 and K-3 for reporting of items of international relevance to partners or shareholders of entities filing Forms 1065, 1120-S, or 8865.

Within FAQ-15, the IRS outlines additional relief for the 2021 tax year for certain filers, which is welcome news for many domestic partnerships and S corporations that don’t have direct foreign ownership or activities.

New Schedules K-2 and K-3

For tax years beginning in 2021, partnerships and S corporations with items of international tax relevance are required to file Schedule K-2 with Forms 1065 and 1120-S as well as provide each partner and S corporation shareholder a Schedule K-3 with their respective Schedule K-1.

“Items of international tax relevance,” in this instance, refers to any information deemed as such given US tax, withholding tax, or other reporting obligations as determined under the international provisions of the Internal Revenue Code. Determining the need for Schedules K-2 and K-3 would require partner or shareholder analysis.

More on FAQ-15

The FAQs come in response to concerns about the service received, emphasizing the need for possible filings, even for partnerships and S corporations that don’t have any direct foreign partners or investments.

Many sections of the schedules are designed to assist individuals and corporations in computing their foreign tax credits. For example, if an individual partner claims a credit for foreign taxes paid, the partner may need certain information from the partnership to complete Form 1116 and Form 1118 in the case of corporate partners.

Filing Relief in 2021

FAQ-15 outlines a new exception for the 2021 tax year when filing Schedules K-2 and K-3 for certain domestic partnerships and S corporations. To qualify for this exception, the following must be met within the tax year specified below.

For the 2021 tax year,

• Direct partners in the domestic partnership can’t be foreign partnerships, corporations, individuals, estates, or trusts.
• Domestic partnerships or S corporations can’t have any foreign activity, including foreign taxes paid or accrued or ownership of assets that generate, generated, or may reasonably expect to generate foreign source income.
• The domestic partnership or S corporation can’t have any knowledge that the partners or shareholders requested such information for the 2021 tax year.

For the 2020 tax year, the domestic partnership or S corporation can’t have provided to its partners or shareholders, nor could the partners or shareholders have requested information regarding:

• Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S)
• 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)

If a partnership or S corporation qualifies for this exception, the domestic partnership or S corporation doesn’t need to file Schedules K-2 and K-3 with the IRS or provide Schedule K-3 to its partners or shareholders for the 2021 tax year.

However, if a partner or shareholder subsequently asks for the Schedule K-3 information, 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 won’t have been met, and the partnership or S corporation will have to must provide the Schedule K-3 to the partner or shareholder and file the Schedules K-2 and K-3 with the IRS.

Notice 2021-39 Penalty Relief

The IRS may impose penalties due to incorrect or incomplete reporting on Schedules K-2 and K-3 unless the taxpayer can demonstrate reasonable cause.

The IRS previously issued Notice 2021-39 to allow some transition relief from penalties for taxable years beginning in 2021 if the filer establishes to the satisfaction of the commissioner that it made a good faith effort to comply with the new reporting requirements.

Next Steps

While certain filing and penalty relief has been enacted for 2021, it's important for taxpayers to understand the impact, if any, that the new filing requirements have as the schedules continue to evolve.

The use of extensions is encouraged this year because the schedules can’t be electronically filed until after the March 15 partnership and S corporation tax deadline making it necessary to remit the forms in PDF format.  

We’re Here to Help

For help understanding the impact of the new Schedules K-2 and K-3 on your organization, contact your Moss Adams professional.

You can also visit our Tax Planning Resource page for additional insights.