Schedules K-2 and K-3 Filing Requirements Update
By Tom Ochsenschlager, J.D., CPA
The Tax Cuts and Jobs Act enacted in 2007 required taxpayers to provide more information relevant to international tax matters. The IRS believed there was significant inconsistency reporting the items of international tax relevance on the Form K-1 and therefore is now increasing the detail required for the reporting.
To comply with this legislative requirement and to clarify items of international tax relevance, in June 2021, the IRS released Schedules K-2 and K-3 that are, in effect, a replacement (enhancement) of line 16a-r and line 20 of the K-1. The K-2 and K-3 must now be included in the filing of Forms 1065 and 1120-S. Generally, the Schedule K-2 will be filed with the partnership or S corporation return while the K-3 will be included with the individual partner’s or shareholder’s K-1s. Although these schedules relate to international tax matters, in January 2022, the IRS announced it would require the forms to be filed even in circumstances where the entity does not have foreign partners, foreign source income, foreign assets that generate income or foreign taxes paid or accrued. The rationale for this seemingly unnecessary requirement is that, in some circumstances, a partner or shareholder is claiming a foreign tax credit that would require specific information from the partnership or S corp.
The IRS has clarified that partnerships and S corps did not need to file the Forms K-2 and K-3 for the 2021 tax year if none of the partners were foreign partnerships, corporations, individuals, or estates or trusts, and the S corporation or partnerships had no foreign activity, foreign taxes or ownership of assets that did or could be expected to generate foreign source income.
On Oct. 25, 2022, the IRS released drafts of the partnership and partners’ instructions for Schedules K-2 and K-3 and requested comments regarding the drafts be submitted by Nov. 8.
The IRS has submitted responses on its website to 27 of the questions it has been receiving: Schedules K-2 and K-3 Frequently Asked Questions (Forms 1065, 1120S, and 8865).
The draft forms are available at 2022 Partnership Instructions for Schedules K-2 and K-3 (Form 1065).
IRS Publishes Draft of 2022 Form 1065 K-2 and K-3 Instructions With Revised Exemptions from Filing — Current Federal Tax Developments