For 2021, IRS added Schedules K-2 and K-3 for Partnerships and S Corporations. These schedules are an extension of Schedule K and K-1 reporting items of international tax relevance.
New domestic filing exception: According to the IRS’s recently released draft instructions for Form 1065 and 1120S Schedules K-2 and K-3, for tax years beginning in 2022, a domestic partnership can avoid completing and filing Schedules K-2 and K-3 if each of the following criteria are met:
- No or limited foreign activity that has less than $300 of foreign tax paid or withheld thereon and which is otherwise reported to the entity during tax year 2022;
- During 2022, all direct partners are U.S. citizens/resident aliens, domestic decedent’s estates with only U.S.-citizen/ resident-alien beneficiaries, domestic grantor trusts with only U.S.-citizen/resident-alien grantors and beneficiaries, domestic non-grantor trusts with only U.S.-citizen/resident-alien beneficiaries, S corporations with a sole shareholder, or single-member LLCs that are disregarded entities and have as their sole member any of the other eligible categories of partners;
- Partnerships that satisfy criteria 1 & 2 must give partners written notification no later than when the partnership furnishes Schedule K-1 to the partner stating that the Schedule K-3 will not be provided by the entity unless the partners request the schedule (NOTE – The original draft instructions would have required notification by January 15th but this date was removed in the revised draft instructions issued 12/2/22). The notice can be provided as an attachment to the Schedule K-1;AND
- No partner requests Schedule K-3 prior to “one month” of the date the partnership files its Form 1065 (August 15, 2023 is the latest date if the calendar year partnership files an extension).
If a partner requests Schedule K-3 information after the “one month” date, the partnership will need to provide Schedule K-3 with the requested information to the requesting partner (but is not required to file that Schedule K-3 with the IRS). Also, because the partnership received a request after the “one month” date for 2022, for 2023, the partnership must complete and file Schedules K-2 and K-3 with respect to the requesting partner with the 2023 Partnership Form 1065.
The domestic filing exception for S Corporations is very similar to the one for partnerships. However, unlike the four criteria partnerships must meet, S Corporations are required to meet three tests. The one requirement omitted relates to US citizens / resident aliens since S Corporations aren’t permitted to have the latter member as shareholders.
Action required to meet the exception
Calendar year Partnerships/S-Corporations must give written notification (by mail or electronically by e-mail) no later than when the Schedule K-1 is furnished to the partner) stating that the Schedule K-3 will not be provided by the entity unless the partners/shareholders request the schedule.
Action may be required for Partners and S Corporation Owners who receive the notification
Partners and S Corporation owners have until one month before the partnership files its Form 1065, including extensions, to request a K-3 to receive it at the same time as their K-1. However, Partners and S Corporation owners can request the information at any time and the entity generally has one month to provide it.
Other 2022 schedule K-2/K-3 changes
- Part I now requires gain reporting, rather than proceeds and cost basis, and only Short-term or Long-term is required.
- Stock sales may be combined on a by country basis
- New country code “XX” is added to the list of options if the country cannot be determined
Form 1116 FTC Exemption: If a Partnership / S Corporation does not meet the “domestic filing exception” discussed above, it may still meet the Form 1116 Exemption to filing the Schedules K-2 and K-3 if the foreign taxes paid are less than $300 for unmarried taxpayers or $600 for married filing joint taxpayers.
- A Partnership/ S-Corporation is not required to complete Schedule K-2 and K-3 if all partners/ S-Corporation owners are eligible for the Form 1116 exemption. In other words, if the Partnership/ S-Corporation has no direct or indirect partner/owner that would be able to claim a foreign tax credit requiring the use of Form 1116, it is exempt from filing Schedules K-2 and K-3.
- If a Partnership/ S-Corporation receives notification from only some of the partners/owners that they are eligible for the Form 1116 exemption, the Partnership/S-Corporation doesn’t need to complete the schedule K-2 and K-3 for those exempt partners/owners but must complete the Schedules K-2 and K-3 with respect to the other partners/owners.
Please note that the above is based on the draft IRS instructions which could change.