Exception for Partnerships & S-Corporations to File Schedules K-2 & K-3

The IRS has added new domestic filing exceptions for partnerships and S-corporations for filing and furnishing Schedules K-2 and K-3 for tax years beginning in 2022.

Background

For tax years beginning in 2021, the IRS released new schedules for pass-through international tax reporting. The new standardized format assists pass-through entities in providing partners and shareholders with the information necessary to complete their returns with respect to the international tax aspects of the Code and allows the IRS to verify tax compliance more efficiently. The forms required for partnerships with an interest in foreign partnerships:

  • Schedule K-2, Partners’ Distributive Share Items – International; and
  • Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc. – International

Partnership Exception

A domestic partnership does not need to complete and file Schedules K-2 and K-3, or furnish a Schedule K-3 to a partner (except if requested by a partner after the 1-month date) if each of the following four criteria are met:

1. No or limited foreign activity. During a domestic partnership’s tax year, the domestic partnership either has no foreign activity or if it does have foreign activity, such foreign activity is limited to (a) passive category foreign income; (b) upon which not more than $300 of foreign income taxes allowable as a credit are treated as paid or accrued by the partnership; and (c) such income and taxes are shown on a payee statement that is furnished or treated as furnished to the partnership;

2. U.S. citizen/resident alien partners. During tax year, all the direct partners in the domestic partnership are: (a) individuals that are U.S. citizens; (b) individuals that are resident aliens; (c) domestic decedent’s estates (that is, decedent’s estates that are not foreign estates), with solely U.S. citizen and/or resident alien individual beneficiaries; (d) domestic grantor trusts that are not foreign trusts and that have solely U.S. citizen and/or resident alien individual grantors and solely U.S. citizen and/or resident alien individual beneficiaries; or (e) domestic non-grantor trusts with solely U.S. citizen and/or resident alien individual beneficiaries;

3. Partner notification. With respect to a partnership that satisfies criteria 1 and 2, the partners must receive a notification from the partnership at the latest when the partnership furnishes the Schedule K-1 to the partner. The notice can be provided as an attachment to the Schedule K-1. The notification must state that partners will not receive Schedule K-3 from the partnership unless the partners request the schedule. See Partner/Shareholder Notification section below; and

4. No Schedule K-3 requests by the 1-month date. The partnership does not receive a request from any partner for Schedule K-3 information on or before the 1-month date. The “1-month date” is one month before the due date the partnership filed Form 1065. For tax year 2022 calendar year partnerships, the latest 1-month date is August 15, 2023, if the partnership files an extension.

If a partnership receives a request from a partner for the Schedule K-3 information after the 1-month date and has not received a request from any other partner for Schedule K-3 information on or before the 1-month date, the domestic filing exception is met and the partnership is not required to file the Schedules K-2 and K-3 with the IRS or furnish the Schedule K-3 to the non-requesting partners. However, the partnership is required to provide the Schedule K-3, completed with the requested information, to the requesting partner on the later of the date on which the partnership files the Form 1065 or one month from the date on which the partnership receives the request from the partner.

If the partnership received a request from a partner for Schedule K-3 information on or before the 1-month date and therefore the partnership does not satisfy criterion 4, the partnership is required to file the Schedules K-2 and K-3 with the IRS and furnish the Schedule K-3 to the requesting partner. The Schedules K-2 and K-3 are required to be completed only with respect to the parts and sections relevant to the requesting partner.

S-Corporation Exception

An S-corporation does not need to complete and file Schedules K-2 and K-3, or furnish a Schedule K-3 to a shareholder, (except if requested by a shareholder after the 1-month date) if each of the following three criteria are met:

1. No or limited foreign activity. During a domestic s-corporation’s tax year, the domestic S-corporation either has no foreign activity or if it does have foreign activity, such foreign activity is limited to (a) passive category foreign income; (b) upon which not more than $300 of foreign income taxes allowable as a credit under IRC 901 are treated as paid or accrued by the S-corporation, and (c) such income and taxes are shown on a payee statement that is furnished or treated as furnished to the s-corporation;

2. Shareholder notification. With respect to an S-corporation that satisfies criteria 1, the shareholders must receive a notification from the S-corporation either electronically or by mail dated no later than two months before the due date (without extension) for filing the S-corporation’s tax year Form 1120-S (January 15, 2023). See Partner/Shareholder Notification section below; and

3. No Schedule K-3 requests by the 1-month date. If an S-corporation receives a request from a shareholder for Schedule K-3 information after the 1-month date and has not received a request from any other shareholder for Schedule K-3 information on or before the 1-month date, the domestic filing exception is met , and the S-corporation is not required to file the Schedules K-2 and K-3 with the IRS or furnish the Schedule K-3 to the non-requesting shareholders. The “1-month date” is one month before the due date (without extension) of the S-corporation’s Form 1120-S (February 15, 2023). However, the S-corporation is required to provide the Schedule K-3, complete with the requested information, to the requesting shareholder on the later of: (1) the date on which the S-corporation files Form 1120-S, or (2) one month from the date on which the S-corporation receives the request from the shareholder. If an S-corporations that satisfy criteria 1 and 2, but do not satisfy criterion 3. It the S-corporation received a request from a shareholder for Schedule K-3, information on or before the 1-month date and therefore the S-corporation does not satisfy criterion 3, the S-corporation is required to file the Schedules K-2 and K-3 with the IRS and furnish the Schedule K-3 to the requesting shareholder.

Partner/Shareholder Notification

Pass-through entities that meet the criteria as indicated above need to provide notification to either the partners or shareholders of the entity by January 15, 2023. The notification must state that partners/shareholders will not receive Schedule K-3 from the pass through entity unless the partner/shareholder requests the schedule. For a template letter to send to your partners/shareholders click here.

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