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Schedules K-2 and K-3 for international activity related to Forms 1065, 1120-S and 8865

Services: Tax

New this year, IRS Schedules K-2 and K-3 will need to be completed to include items of international tax relevance from the operations of a pass-through entity.

If the entity has international financial activity –– which could be as simple as holding investments that pay foreign taxes –– it will be required to report on these new schedules if it files:

Schedules K-2 and K-3 replace, supplement and clarify the reporting of certain amounts formerly reported on a partner’s or shareholder’s Schedule K-1 as foreign transactions. These new schedules are longer and will likely require additional time for us to complete.

The new standardized format assists pass-through entities in providing partners or shareholders with the information necessary to complete their returns with respect to international tax aspects and allows the IRS to verify tax compliance more efficiently. Failure to file such forms or properly provide these information statements to partners or shareholders can result in significant penalties.

There are nuances to the reporting requirements, such as potentially determining whether each partner’s or shareholder’s respective income tax returns contain Form 1116, Foreign Tax Credit, or other international tax forms. If applicable, the pass-through entity may be required to file Schedules K-2 and K-3. To help determine if Schedules K-2 and K-3 are needed, you should consider surveying the partners or shareholders for certain information to help with compliance.

On February 16, 2022, the IRS has provided some transitional relief that may apply to your business for the 2021 tax year.  To qualify for this relief, the following must be met:

If a partnership or S corporation qualifies for this exception, the domestic partnership or S corporation does not need to file Schedules K-2 and K-3 with the IRS or with its partners or shareholders.  However, if the partnership or S corporation is subsequently notified by a partner or shareholder that all or part of the information contained on Schedule K-3 is needed to complete their tax return, then 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 are not met 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.

Because of these new rules and delays with the IRS accepting these schedules for electronically filed returns, a tax return filing extension may be needed to file a complete and accurate return.

Pease feel free to reach out with any questions or concerns.  As always, we appreciate the opportunity to serve you.