Effective for the 2021 tax year, the IRS has added two new forms for pass-through entities for purposes of disclosing additional international information as a result of the Tax Cuts and Jobs Act of 2017.
The new forms are: Schedules K-2 (Partners’ Distributive Share Items—International/Shareholders’ Pro Rata Share Items—International) and K-3 (Partner’s/Shareholder’s Share of Income, Deductions, Credits, etc.—International). The forms are primarily intended for pass-through entities with foreign operations or foreign owners whose owners need additional information to comply with newer international reporting requirements.
Schedules K-2 and K-3 are intended for use with:
- Form 1065 – U.S. Return of Partnership Income
- Form 1120-S – U.S. Income Tax Return for an S Corporation
- Form 8865 – Return of U.S. Persons with Respect to Certain Foreign Partnerships
Subsequent to the initial release of the forms, the IRS published additional guidance casting a very broad net on pass-through entities required to file the forms. The expansion included the requirement for many domestic flow-through entities with no foreign activities or owners. After severe pushback from the tax practitioner community, the IRS has once again updated its guidance specific to domestic only flow-through entities to provide at least some level of relief for the 2021 filing season per FAQ 15 from its website as follows:
“The IRS is providing an additional exception for tax year 2021 to filing the Schedules K-2 and K-3 for certain domestic 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.
If a partnership or S corporation qualifies for this exception, the domestic partnership or S corporation does not need to file Schedules K-2 and K-3 with the IRS or with its partners or shareholders. However, if the partnership or S corporation is subsequently notified by a partner or shareholder that all or part of the information contained on Schedule K-3 is needed to complete their tax return, then the partnership or S corporation must provide the information to the partner or shareholder. If a partner or shareholder notifies the partnership or S corporation before the partnership or S corporation files its return, the conditions for the exception are not met and the partnership or S corporation must provide the Schedule K-3 to the partner or shareholder and file the Schedules K-2 and K-3 with the IRS.”
While certainly a step in the right direction, the IRS still included some confusing language that is open to interpretation in this new FAQ. Additionally, most tax practitioners feel this new relief does not go far enough. For example, a partnership or S corporation with an owner that has a brokerage account with foreign tax could require the filing of these forms. The IRS continues to have pushback in this area, so we are hopeful that further relief will be forthcoming. Please note that the IRS has previously announced penalty relief provisions in Notice 2021-39. However, the relief from this notice in many instances was very narrow and burdensome which contributed to the additional relief discussed above.
Please be advised that further complications for these forms include delay in ability to eFile flow-through entity returns. Forms for 1065 are delayed until March 20, while those for 1120S are delayed until mid-June.
It is important to note that these dates occur after the initial filing deadline of March 15, 2022, for pass-through entities has passed. Therefore, it is important for impacted taxpayers to strongly consider extending their pass-through returns. In the meantime, IRS will accept the forms as PDF attachments. However, this is a burdensome process, especially for larger taxpayers.
Please note that this recent guidance gives relief for the 2021 tax filing season only. For now, the requirements will go into effect for tax year 2022, potentially creating additional filing obligations for many flow-through entities that could be caught unaware.
CSH will continue to monitor developments in this area and provide additional updates as needed. Contact us with questions.