IRS Releases More Guidance for Schedules K-2 and K-3
On February 16, 2022, the IRS posted to its website new frequently asked questions and responses (“FAQs”) regarding Schedules K-2 and K-3. The FAQs provide further guidance, explanation, and some relief to partnerships and S corporations that are filing 2021 tax returns and may need to include Schedules K-2 and K-3.
Please see our article, Will Your Business Tax Return Include New Schedules K-2/K-3? to learn more on the requirements to file Schedules K-2 and K-3.
Exception for Filing Forms Schedule K-2 and K-3
The IRS response to Question 15 brings welcome news for many taxpayers. The IRS carves out an additional exception to filing Forms Schedule K-2 and K-3 for tax year 2021 for certain U.S. partnerships and S corporations.
To qualify for this exception, the following must be met:
- In tax year 2021, the direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts.
- In tax year 2021, 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 (see section 1.861-9(g)(3)).
- In tax year 2020, 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 tax year 2021.
Question 15 goes on to say that if a partner or shareholder requests the information that would have been included in Schedule K-3, the partnership or S corporation must provide such information.
The IRS provides an important reminder in its response to Question 10. In accordance with Notice 2021-39, a partnership or S corporation will not be subject to penalties if there is a good faith effort to 1) determine which parts, if any, of Schedules K-2 and K-3 must be completed, and 2) how to actually complete any required parts of these tax forms.
Your Cherry Bekaert tax advisor can discuss with you whether your partnership or S corporation may qualify for this new limited exception to filing Schedules K-2 and K-3.