New Tax Forms Required for Many Partnerships & S-Corporations: Introducing Schedules K-2 and K-3
By Odhra Labarraque, Senior Manager, Tax & Business Services
With tax season underway, those invested in partnerships and S-corporations should note new forms will be required to accompany 2021 tax returns. The new tax forms, Schedule K-2 and Schedule K-3, provide additional information regarding foreign income, deductions, taxes and credits, as well as other miscellaneous items of international tax relevance.
The Schedules K-2 and K-3 expand on the information historically reported under “Foreign Transactions” and “Other Information” on Schedules K and K-1, and within the footnotes of these forms. Schedule K-2 is an expansion of Schedule K, and Schedule K-3 is an expansion of Schedule K-1. Both are significant in length, with 11 parts (19 pages) and 13 parts (20 pages), respectively, for partnership filings, and only minimally less for S-corporation filings.
The IRS and Treasury announced that these additions were coming in July 2020, through the issuance of drafted forms and instructions.
The language in the introductory sections of the instructions to these new forms is somewhat misleading, appearing to state that filing requirements apply only to pass-through entities that have foreign activities or foreign owners (“Who Must File: The partnership need not complete this schedule if the partnership does not have items of international tax relevance (typically, international activities or foreign partners)”).
But the devil is in the details (and in the recent changes to the instructions issued by the IRS on January 18, 2022).
Every pass-through entity needs to determine if it has items of international tax relevance with respect to its direct and indirect owners. For instance, a U.S. entity with no foreign-sourced income, no assets generating foreign-sourced income, no foreign taxes paid or accrued, and no foreign owners may still need to report information on Schedules K-2 and K-3 if an owner is eligible to claim a credit for foreign taxes paid on other sources of foreign income on their own tax return.
Furthermore, the forms are required if the entity lacks positive evidence that each owner is not eligible to claim a foreign tax credit on their return. In other words, if the entity is unsure if an owner may be claiming a foreign tax credit on their return, these new forms are required.
This is a simple example of the threshold for filing and the rules to determine filing requirements. The process of gathering, analyzing, and reporting all the data required is complex and may consume a substantial amount of time, resources, and cost to complete properly.
On a positive note, Schedules K-2 and K-3 provide more transparency and clarity, as well as a standard format to report international tax information for the owners of pass-through entities.
The IRS is offering transition relief for failure to furnish complete and correct information this first year (i.e., for filings in 2022 related to the 2021 tax year), but taxpayers must demonstrate that a good faith effort was made to comply with the new reporting requirements.
Much is still unknown and undetermined about these new forms, as they are complex and extensive and may require many filers to be placed on extension. Your Marcum tax professionals will continue to keep you updated on these complex requirements.
More so than ever, planning and communication is crucial this year, and we encourage you to discuss your unique facts and circumstances with your tax advisors as early as possible. The international tax group at Marcum LLP is ready to assist you.