Partnerships and S Corporations Face New K-2 and K-3 Filing Requirements by Claribel Velazquez, CPA
Beginning with tax year 2021, the IRS required partnerships, S corporations and other pass-through entities with “international tax relevance” to annually prepare new Schedules K-2,
Partners’ Distributive Share Items – International, and K-3, Partner’s Share of Income, Deductions, Credits, etc. – International along with their Schedules K and K-1. Today, however, as these entities prepare to file their U.S. federal income tax returns for 2022, some will find they qualify for a new domestic filing exemption from these rules.
The reporting requirements introduced for the 2021 tax year were designed to help partnerships and S corporations more easily calculate their U.S. tax liabilities on foreign-source income, investments and tax credits and share that information consistently with all their partners and shareholders to report on their individual U.S. income tax returns. In turn, the IRS can more easily verify reporting among partnerships and their partners and shareholders, thereby ensuring cross-border tax compliance and limiting the potential for IRS examinations.
In October 2022, the IRS created a domestic filing exception containing a new exception to the requirement that partnerships and S corporations file and furnish the schedules for tax years beginning in 2022. However, taxpayers are finding that qualifying for this exemption is not as easy as they originally thought.
Under the law, a domestic partnership or S corporation does not need to send, complete or file with the IRS Schedules K-2 and K-3 or provide to its partners or shareholders Schedule K-3 (except when requested by a shareholder or partner after the one-month date) when it meets the following criteria for tax year 2022:
The domestic partnership/S corporation has limited or no foreign activity
Under the IRS’s definition, no foreign activity means the domestic partnership/S corporation does not have 1) paid or accrued foreign income taxes 2) foreign source income or losses 3) ownership interest in a foreign partnership 4) ownership interest in a foreign corporation 5) ownership of a foreign branch 6) ownership interest in a foreign entity that is treated as a disregarded entity separate from its owner.
When there is foreign activity, the domestic partnership/S corporation may qualify for the K-2 and K-3 filing exception only when that activity involves 1) passive foreign income, 2) for which foreign taxes paid or accrued is $300 or less, and 3) such income and taxes are shown on a payee statement furnished to the domestic partnership/S corporation.
Direct partners in the partnership are U.S. citizens/resident aliens
For a domestic partnership to be exempt from K-2 and K-3 reporting for tax year 2022, all of its direct partners must be individuals who are either a U.S. citizen or resident alien; a domestic decedent’s estate with solely U.S. citizens or resident aliens as beneficiaries ; a domestic grantor trust with only U.S. citizen or resident alien grantors and beneficiaries; a domestic non-grantor trust with solely U.S. citizen and resident alien individual beneficiaries; an S corporation with a sole shareholder; or a single-member LLC disregarded as an entity separate from its sole member/owner who is either a U.S. citizen or resident alien.
The domestic partnership/S corporation properly notifies its partners/shareholders
A partnerships/S corporation seeking a domestic exception must notify its partners/shareholders by the date it furnishes them with a K-1 that the partners/shareholders will not automatically receive a Schedule K-3 unless they specifically request it.
The partnership/S corporation does not receive a 2022 Schedule K-3 requests by the one-month date
The partnership/S corporation does not receive a request for Schedule K-3 information from any of its shareholders or partners by Aug. 15, 2023, which is one month before the partnership’s/S corporation’s federal tax-filing deadlines if the partnership/ S corporation files an extension.
Entities that do not meet the domestic partnership exception must attach Schedules K-2 and K-3 to their partnership tax returns on IRS Form 1065, U.S. Return of Partnership Income, the federally mandated filing deadlines of March 15, 2023, or Sept. 15, 2023, for taxpayers with a filing extension.
About the Author: Claribel Velazquez, CPA, is a senior manager of Tax Services with Berkowitz Pollack Brant Advisors + CPAs, where she provides tax compliance and consulting services to high-net-worth individuals, closely owned businesses and commercial real estate and development businesses. She can be reached at the CPA firm’s Miami office at (305) 379-7000 or firstname.lastname@example.org.