IRS Announces Additional Relief for Partnerships Preparing Schedules K-2 and K-3
To make the move to the new Schedules K-2 and K-3 even easier, the Internal Revenue Service (IRS) published more specifics on further transition relief for certain domestic partnerships and S companies preparing the new schedules. Those who qualify for the relief will not be required to file the updated schedules for the 2021 tax year.
The new schedules K-2 and K-3 simplify reporting by standardizing foreign tax information and making it convenient for partners and flow-through investors to submit these items on their tax returns. In addition, the modifications make it easier to comply with flow-through return preparation by defining obligations and standardizing reporting formats.
Penalty relief is available under Notice 2021-39 for good-faith attempts to adopt the new schedules. Today's transition relief permits certain domestic partnerships and S companies to file for tax year 2021 with an additional exception. For the tax year 2021, the IRS is allowing specified domestic partnerships and S companies to file Schedules K-2 and K-3 without penalty. To be eligible for this exception, you must meet the following criteria:
Foreign partnerships, foreign corporations, foreign people, foreign estates, and foreign trusts are not direct participants in the domestic partnership in tax year 2021.
The domestic partnership or S company has no international activity in tax year 2021, including no foreign taxes paid or accrued or ownership of assets that create, have generated, or may reasonably be expected to generate foreign source income.
The domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting such information for the tax year 2021.
- In tax year 2020, the domestic partnership or S corporation did not provide to its partners or shareholders nor did the partners or shareholders request the information regarding (on the form or attachments thereto):
- Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S), and
- 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 domestic partnership or S corporation qualifies for this exception, it is not required to submit Schedules K-2 and K-3 with the IRS or with its partners or shareholders. If a partner or shareholder later informs the partnership or S corporation that all or part of the information on Schedule K-3 is required to complete their tax return, the partnership or S corporation is required to provide the data to the partner or shareholder. The conditions for the exception are not met if a partner or shareholder informs the partnership or S corporation before the partnership or S corporation files its return, and the partnership or S corporation must provide the Schedule K-3 to the partner or shareholder and file the Schedules K-2 and K-3 with the IRS.
FAQs About Schedules K-2 and K-3
1. What are the Schedules K-2 and K-3?
The 2021 Form 1065 Schedule K-2 is an expansion of Form 1065, Schedule K, and reports items of foreign tax relevance. It takes the place of lines 16a-r, parts of line 20, and a slew of unformatted statements from previous editions of Schedule K. In general, the Form 1065 Schedule K-3 is an extension of the Form 1065 Schedule K-1 and reports a partner's distributive share of items of international tax relevance. Line 16, sections of line 20, and other unformatted statements from previous editions of the Schedule K-1 Form 1065, Schedule K-1 have been replaced. Flow-through entities with items of international tax relevance must complete the updated schedules, as indicated in the instructions and revisions provided on January 18, 2022, for tax years beginning in 2021. The international tax relevance of each part of the new schedule is determined. Forms 1120-S and 8865 have undergone similar modifications.
2. Why is the IRS creating Schedules K-2 and K-3?
The new schedules take into account the complexities of the Tax Cuts and Jobs Act (TCJA). The TCJA mandated a large increase in the amount and types of data needed to determine the US tax liability on items with foreign tax implications. The TCJA has been substantially implemented through various forms, such as Forms 1040 and 1120 and their associated schedules. Following those improvements, the IRS is now implementing changes to flow-through returns to ensure that investors, who are the ultimate taxpayers in the case of flow-through entities, get the information they need to complete their returns correctly. Items of foreign tax relevance were not always disclosed in a clear and consistent fashion on Schedules K and K-1 attachments, according to the IRS in the years following the TCJA. Partnerships and S corporations will be able to report more efficiently if they have clear and consistent forms and instructions.
3. What are the benefits of Schedules K-2 and K-3 for taxpayers?
Partners, partnerships, shareholders, and S corporations will be able to comply with the different complex foreign tax requirements more efficiently if they use consistent and standardized forms and instructions. While there will be some transition expenses for partnerships and S companies, they will ultimately gain from improved information transparency and less uncertainty about what to disclose and how to report it.
4. Do Schedules K-2 and K-3 require new information that previously wasn’t required for partners and shareholders?
Partnerships and S corporations may not have previously disclosed data in the same level of detail or for every fact pattern that requires reporting. The new schedules require more specific and comprehensive reporting to partners and shareholders than partnerships and S corporations may have previously provided, which is required for partners and shareholders to accurately file their own returns.
5. What is the authority underlying Schedules K-2 and K-3?
The IRS bases the content of the schedules on sections of the Internal Revenue Code and regulations that outline the obligations of a partnership and its participants in assessing their tax liability. The IRS relies on Treasury Regulation section 1.6031(a)-1(a)(1) and (2) for the authority to create and require these schedules, which states that every domestic partnership must file a return of partnership income under section 6031 (partnership return) for each taxable year on the form prescribed for the partnership return. The information required by the prescribed form and accompanying instructions must be included in the partnership return.
6. Can these schedules be filed electronically? What is the timeline like?
Yes, these schedules can be submitted electronically at this time. However, effective at the start of the 2022 filing season, the Modernized e-File (MeF)/Extensible Markup Language (XML) electronic filing capability for schedules K-2 and K-3 for tax year 2021 will not be available. In the following time frames, Schedules K-2 and K-3 will be accessible for MeF/XML filing. If you file your return electronically before the deadline, attach the schedules as separate PDF files to the return. For the full 2022 filing season, taxpayers will be able to file their Schedules K-2 and K-3 as PDF attachments.
Form 1065, Schedules K-2 and K-3 March 20, 2022
Form 1120-S, Schedules K-2 and K-3 Mid-June 2022
|Form 8865, Schedules K-2 and K-3 January 2023|