Recent changes mean even entities without any foreign income may now be required to file Schedules K-2 and K-3.
By Paul Fong, CPA, and Yuki Miyajima, CPA
On Jan. 18, 2022, the IRS issued changes to the 2021 Partnership and S-Corporation Instructions for Schedules K-2 and K-3.
Schedule K-2 is an extension of Schedule K of Form 1065 and 1120-S and is used to report items of international tax relevance from the operation of a partnership or an S-Corporation. Schedule K-3 is an extension of Schedule K-1 and is generally used to report to partners or shareholders their share of the items reported on Schedule K-2. Partners or shareholders of a partnership or S-corp must include the information reported on Schedule K-3 on their tax or information returns.
Previously, a partnership or S-corp was required to complete Schedules K-2 and K-3 only if the partnership or S-corp had items of international tax relevance (i.e., international activities or foreign partners). With certain exceptions, the partnership or S-corp was generally not required to obtain information from its direct or indirect partners or shareholders to determine if it needed to file each of these Schedules.
However, the recent changes to the instructions for Schedules K-2 and K-3 indicate that even if a partnership or S-corp has no foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued, it may still have a filing obligation. The instructions provide an example whereby if a partner claims a foreign tax credit paid by the partner, the partner may need certain information from the partnership to complete Form 1116.
Schedule K-2 and K-3 cannot be submitted electronically via Modernized e-File (MeF) or Extensible Markup Language (XML) until March 20, 2022, for partnerships or mid-June 2022 for S-corporations. The IRS has proposed PDF workarounds until forms can be submitted electronically. Changes to our tax software to accommodate the PDFs are being implemented.
One consequence of all these changes is that partnerships and S-corporations including Schedule K-2 and K-3 may need to file extensions this year. Note that failure to file Schedules K-2 or K-3 timely by partnerships or S-corporations and failure to provide relevant information to partners or shareholders may result in substantial penalties. The penalty is $210 per partner or shareholder, per month or portion of a month, for a maximum of 12 months.
As ever, BPM has our attention trained on the tax matters impacting your business so that you can stay informed. As an active BPM client, trust that your BPM Tax team is already making arrangements to account for these changes. However, if you should have further questions about how this development may affect your 2021 tax returns, we encourage you to reach out to your BPM Tax team immediately so that we may work with you to determine the optimal course of action for your unique situation.