On December 23, 2022, the Internal Revenue Service (IRS) finalized the partnership and S corporation instructions for Schedules K-2 and K-3 for 2022. In these revised instructions, the IRS included an updated domestic filing exception and Form 1116 filing exemption exception to provide eligible entities relief from reporting requirements.
Incorporated into the myriad of tax compliance forms, Schedules K-2 and K-3 were required to be completed by partnership and S corporation taxpayers to report items of international tax relevance beginning with the 2021 tax year. Compared to the 2021 FAQ #15 reporting relief requirements, the updated domestic filing exception is more restrictive as it does not apply to entities with corporate or pass-through partners.
Schedules K-2 and K-3 provide consistency in reporting format and generally clarify items required to be reported for foreign tax and foreign activity-related items. For the 2022 tax year, the IRS included relief for some pass-through entities in the form of the updated domestic filing exception and a Form 1116 filing exemption.
Under the domestic filing exception, Schedules K-2 and K-3 are not required to be filed if all four of the following requirements are met:
- Requirement #1 – No or limited foreign activity
- Requirement #2 (not applicable to S corporations) – U.S. citizen/resident alien partners only
- Requirement #3 – Partner notification
- Requirement #4 – No Schedule K-3 requests from partners by “one-month date”
The following highlights a potential timing issue with Requirements #3 and #4:
- Requirement #3 (the notification requirement) requires partnerships to notify partners that they will not receive a Schedule K-3 unless a request is made. The latest that partnerships can notify partners is when furnishing the Schedule K-1 to the partner.
- Requirement #4 is met if the partnership does not receive a request for a Schedule K-3 from any partner one month prior to the partnership filing Form 1065. In addition, if a request is made after the one-month date, the partnership has until the later of the filing date of Form 1065 or one month after the request from the partner was received to provide the Schedule K-3 information to the requesting partner.
Potential partners may not know that they need to request a Schedule K-3 until they receive their Schedule K-1. Although once a request is made, the partnership must provide a Schedule K-3 within one month of the request, but timing could be an issue depending on when the partners are notified potentially through Schedule K-1. If you require information from Schedule K-3 to prepare your tax returns, it is advisable that you make a request to the partnership/S corporation as soon as possible.
If the partnership does not qualify for the domestic filing exception, the partnership is required to file the Schedules K-2 and K-3.
A best practice for partnerships exempt from filing Schedules K-2 and K-3 under the domestic filing exception (and therefore not planning to file those forms) is that they notify partners earlier in the year to avoid the requirement to prepare Schedule K-3 after Form 1065 is filed. There are likely additional costs associated with the preparation of Schedule K-3 in this situation.
If you have questions regarding Schedules K-2 and K-3, or the domestic filing exception, contact us or speak with your BPM tax professional for additional information.
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