IRS Provides Temporary Relief for Schedules K-2 and K-3 (Kinda)

The IRS created Schedules K-2 and K-3 to accommodate the international provisions enacted with the Tax Cuts and Jobs Act of 2017 and to provide consistency in the reporting to partners and shareholders.  Schedule K-2 will be an extension of Schedule K and will be used to report items of international tax relevance from the operation of a partnership or S-Corporation.  Schedule K-3 will be an extension of Schedule K-1 and will report a partner or shareholder’s distributive share of items of international tax relevance.  Both Schedules K-2 and K-3 will replace portions of Line 16, Line 20 and numerous unformatted statements previously attached to Schedules K and K-1. 

The Internal Revenue Service (IRS) recently issued additional guidance for Schedules K-2 and K-3, in the form of frequently asked questions (FAQs).  The FAQs provide temporary relief to qualifying partnerships and S-Corporations for the filing of Schedules K-2 and K-3 with the IRS and/or with its partners or shareholders. This relief is transitional and only applies to the 2021 tax year. 

To qualify for the relief, the following conditions must be met:

• In the 2021 tax year, the direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts. 
• In the 2021 tax year, the domestic partnership or S-Corporation has no foreign activity, including foreign taxes paid or accrued or ownership of assets that generate, have generated, or may reasonably expected to generate foreign source income.
• In the 2020 tax year, the domestic partnership or S-Corporation did not provide to its partners or shareholders nor did the partners or shareholders request the information regarding (on the form or attachments thereto):
  • Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S), and
  • Line 20c, Form 1065, Schedules K and K-1 (Controlled Foreign Corporations, Passive Foreign Investment Companies, 1120-F, section 250, section 864(c)(8), section 721(c) partnerships, and section 7874) (line 17d for Form 1120-S).
• The domestic partnership or S-Corporation has no knowledge that the partners or shareholders are requesting such information for the 2021 tax year.

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 required in order to complete their respective 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 prior to the filing of the partnership or corporate tax return, the conditions for the exception will not be met and the Schedules K-2 and K-3 will have to be filed with the IRS and/or with its partners or shareholders.

Taxpayers who make a good faith effort to comply with the new schedules for the 2021 tax year will not be assessed a penalty, as previously outlined in IRS Notice 2021-39.

Thanks to colleague Kyle Dawley for his assistance with this post.

Source: IRS.gov