What are Schedules K-2 and K-3?

Certain domestic partnerships and S-corporations are required to prepare Schedules K-2 and K-3, which report items of international tax relevance. The schedules are extensions of Form 1065, Schedule K. Schedules K-2 and K-3 may also be required attachments to Forms 1120-S and 8865.

What is considered an item of international tax relevance?

This is a broad list with no concise definition, but examples of items of international tax relevance include:

• Interests in foreign entities or distributions from foreign corporations
• Foreign tax credit information
• Foreign partners’ U.S. source income
• Investments in foreign entities
• Interests in controlled foreign corporations, global intangible low-taxed income (GILTI) and Subpart F income inclusions
• Foreign derived intangible income

What’s new?

As of the 2021 tax year, flow through entities with items of international tax relevance are required to complete Schedules K-2 and K-3.

The information that is reported on these forms is not new – partners and S-corporation shareholders have long been responsible for reporting this information to the IRS. Rather, these new schedules are intended to address issues that partners and S-corporation shareholders have had with synthesizing the information which had previously come to them in a variety of formats. The IRS has introduced the Schedules K-2 and K-3 to standardize this reporting for taxpayers, while making its own review of the provided information more efficient.

Despite the intention to make the reporting more standardized for taxpayers and efficient for the IRS, the forms are not simple to complete. The Schedule K-2, which provides the entity-level reporting, has eleven sections which cover 19 pages (the versions of the K-2 which are attached to Forms 1120-S and 8865 are slightly less onerous, with seven and eight sections, respectively, each covering 14 pages). The Schedule K-3 provides each partner’s or S-corporation shareholder’s share of the information reported on Schedule K-2.

Based on the instructions that the IRS initially released and the initial guidance it provided to taxpayers, it appeared that nearly every taxpayer filing a Form 1065, 1120-S or 8865 would be required to include Schedules K-2 and K-3 unless the determination could be made definitively that no partner or S-corporation shareholder had any items of international tax relevance.

Has the IRS offered Taxpayers any relief from these requirements?

The IRS provided taxpayers with transitional relief on February 16, 2022 via News Release IR-2022-38. Taxpayers eligible for the transitional relief will not have to file the new schedules for tax year 2021.

This relief applies where:

• None of the direct partners in a domestic partnership are foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts for tax year 2021
• a domestic partnership or S-corporation does not have foreign activity during the 2021 tax year, or
• during tax year 2020, a domestic partnership or S-corporation did not provide partners or shareholders information pertaining to:
  • 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, Sec. 250, Sec. 864(c)(8), Sec. 721(c) partnerships, and Sec. 7874) (line 17d for Form 1120-S).

Questions? These forms can be difficult to complete. We can help. Contact us.