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Partners Required to File Forms K-2 and K-3 Even if Only U.S. Source Income (In Most Situations)

By Josh Whitworth, CPA-Dallas

On Jan. 18, 2022, the IRS updated its instructions to the Schedules K-2 and K-3. These additional modifications to instructions make it clear that partnerships may need to file Forms K-2 and K-3 even if the partnership has no foreign source income, deductions or foreign tax credits. This is a change from the original instructions where the “Who Must File” section began with the following:

The partnership need not complete this schedule if the partnership does not have items of international tax relevance (typically, international activities or foreign partners).

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This section did not mention that there would be cases in which partnerships with neither international activities nor foreign partners would have to complete these forms.

The following paragraph has now been added to the “Who Must File” section:

Note. A partnership with no foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3. For example, if the partner claims a credit for foreign taxes paid by the partner, the partner may need certain information from the partnership to complete Form 1116. Also, a partnership that has only domestic partners may still be required to complete Part IX when the partnership makes certain deductible payments to foreign related parties of its domestic partners. The information reported in Part IX will assist any domestic corporate partner in determining the amount of base erosion payments made through the partnership, and in determining if the partners are subject to the Base Erosion and Anti-Abuse Tax. See each part for applicability.

This note would seem to clearly infer that partnerships would need to provide applicable gross income to its partners even if all income is U.S. source. 

The original instructions indicated if no activity of international relevance or no foreign partners that these forms would not be required under “Who Must File.” However, page 7 of original instructions beginning at the section entitled “Schedule K-2, Parts II and III, and Schedule K-3, Parts II and III” mentioned that partners claiming the foreign tax credit due to other items on their respective returns could require the partnership to complete these parts:

Certain partners will use the following information to claim and figure a foreign tax credit on Form 1116 or 1118. Schedules K-2 and K-3, Parts II and III, must be completed unless the partnership does not have a direct or indirect partner that is eligible to claim a foreign tax credit and such partner would have to file a Form 1116 or Form 1118 to claim a credit.

The instructions continue to say the information will need to be provided by the partnership even if the partnership has no foreign activity.

This requirement applies regardless of whether the partnership pays or accrues foreign taxes because other information, such as the source of the partnership’s income and the value of its assets, are relevant in determining the partner’s foreign tax credit. A partner that is eligible to claim a foreign tax credit includes a domestic corporation, a U.S. citizen or resident, certain U.S. trusts and estates, certain foreign corporations, and certain nonresident individuals.

The partnership may still be able to avoid filing this form if the partnership can certify that none of its underlying partners have any foreign source income or any activity with international relevance.

Schedule K-2 and Schedule K-3, Parts II and III, would be the only parts required by the partnership if there was no other activities of international relevance or foreign partners and the only reason for filing was to provide its partners the necessary information for them to complete their applicable Form 1116 or Form 1118, if applicable.

Please note that these modifications apply to S corporations as well.

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