Beginning with tax year 2021, partnerships and S corporation taxpayers that had items of international tax relevance were required to file two additional forms: Schedule K-2 (Partners’ Distributive Share Items—International) and K-3 (Partners’ Share of Income, Deductions, Credits, etc.—International) along with Form 1065 or 1120-S.
For the 2022 tax year, the IRS has released updated instructions for schedules K-2 and K-3. These instructions include the domestic filing exception, which exempt taxpayers from filing these schedules with the government or furnishing the schedules to partners if the entity meets certain requirements. While filing relief was available for tax year 2021, it’s important to review the updated requirements to determine whether you will need to include these schedules as part of your 2022 returns.
Does Your Partnership or S Corp Need to File a K-2 or K-3 for Its 2021 Taxes?
How Does the K-2 and K-3 Domestic Filing Exception Impact Partnerships?
The domestic filing exception is available for partnerships that:
- Meet certain eligibility criteria,
- Provide notice to its partners, and
- Do not receive a request for such information from any partner.
To be eligible for the domestic filing exception:
The list above does not include C corporations, partnerships or S corporations with multiple shareholders. The exclusion of these partners could minimize the applicability of the exception even in situations where the information would not have been requested.
The partnership must be a domestic partnership. Domestic for this purposes means the partnership was created or organized in the U.S. or under the laws of the U.S. or any state.
All direct partners of the partnership must be:
- U.S. citizen individuals;
- Resident alien individuals;
- Domestic decedents’ estates with solely U.S. citizen and/or resident alien individual beneficiaries;
- Domestic grantor trusts whose grantor(s) and beneficiaries are solely U.S. citizen and/or resident alien individuals;
- Domestic non-grantor trusts with solely U.S. citizen and/or resident alien individual beneficiaries;
- S corporations with a sole shareholder; or
- Single-member LLC that is disregarded for tax purposes and the sole member meets the requirements above.
The partnership must have no foreign activity or limited foreign activity. Limited foreign activity for this purpose means:
- Only passive category foreign source income;
- $300 or less of foreign taxes allowable as a credit; and
- The income and taxes described above are reported to the partnership on a payee statement, for example, Schedule K-1 or Form 1099.
A partnership that meets the eligibility criteria above and wishes to use the domestic filing exception must notify each of its partners that a Schedule K-3 will not be provided unless the partner requests it. Partners must be notified no later than when the partnership furnishes the Schedule K-1 to the partner.
While the notification timing — relaxed from earlier versions of the instructions — may simplify the process for eligible partnerships, notifying your partners ahead of time could make sense depending on your facts and circumstances.
Your entity still may have to report on schedules K-2 and K-3 even if it meets the qualifications above. Any obligation will depend on whether a partner requests the information and when the partnership receives that request.
The key timeframe to understand is the one-month date, which is defined as one month before the date the partnership files its return:
A partnership that receives a request after the one-month date is not required to file a schedule K-2 and K-3 with the government. However, the partnership must provide the requesting partner a Schedule K-3 with the requested information.
A partnership that receives a request on or before the one-month date must file a schedule K-2 and K-3 with the government and provide the requesting partner a Schedule K-3 with the requested information. The partnership is only required to complete the parts and sections of the schedules requested by the requesting partner(s).
How Does the K-2 and K-3 Domestic Filing Exception Work for S Corporations?
The rules for S corporations are the same as partnerships; however, items 1 and 2 under eligibility criteria are not applicable, since an S corporation by nature would already satisfy these requirements. The other requirements for partnerships also hold true for S corporations; they must:
Have no or limited foreign activity;
Provide notice to its shareholders; and
Not receive a request for such information from any shareholder.
Taxpayers should review the current rules of the Domestic Filing Exception with their tax professionals to determine applicability and decide when and how to provide notice to partners.
Contact Robert Venables at firstname.lastname@example.org or a member of your service team to discuss this topic further.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.