The IRS continues to implement the international tax changes from the Tax Cuts and Jobs Act, and this latest update affects pass-through entities. Starting with the 2021 tax year, S Corporations, domestic partnerships and foreign partnerships with items with “international relevance” must complete the new Schedule K-2 and Schedule K-3. To help pass-through entities prepare for a smooth filing season, we take a closer look at the new schedules and how they will be used.
Who needs to file these schedules?
Some pass-through entities may be surprised to discover a K-2 and K-3 filing requirement based on the IRS’ broad definition of international relevance, which would include the following situations:
- Pass-through entities with non-U.S. activities, including foreign subsidiaries, export sales and payments made to non-U.S. parties
- Pass-through entities with foreign partners or shareholders
- Pass-through entities with partners or shareholders that have foreign activities
The third group may come as a surprise to many filers who only have domestic activities. However, these schedules will provide taxpayers with the necessary information for partners and shareholders to complete their filing obligations related to international provisions such as foreign tax credit limitation calculations.
Schedules K-2 and K-3 overview
These schedules are intended to establish a standardized method of providing information necessary to complete the various international aspects of the Tax Cut and Jobs Act. Many filers may already be accumulating and providing this required information through Schedule K-1 and related disclosure attachments. Transitioning the disclosure of this information to Schedules K-2 and K-3 should allow the IRS to review pass-through tax returns more efficiently, rather than manually processing them.
- Schedule K-2: This 14-page schedule for Form 1120-S and 8865 filers and 19-page schedule for Form 1065 filers replace the Schedule K, line 16 information previously completed for these returns. This schedule will provide the international components and information needed at a partner level. In addition to providing information necessary for foreign tax credits, global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII) and Base Erosion and Anti-Abuse Tax (BEAT) provisions, this schedule will highlight whether additional forms are required related to foreign investments in subsidiaries or branch entities.
- Schedule K-3: This 15-page schedule for Form 1120-S and 8865 filers and 20-page schedule for Form 1065 filers replace the line 14 (Form 1120-S) or line 16 (Form 1065) information and the lengthy number of codes of the K-1. This schedule provides partners and shareholders with their respective share of international information provided on Schedule K-2.
Transition penalty relief for pass-through entities
These schedules are quite voluminous on their own, with the potential of additional workpapers or attachments. The IRS appears to recognize the heavy lifting involved, offering penalty relief under Notice 2021-39 for filers who make a good faith effort to comply with Schedule K-2 and Schedule K-3 reporting for the 2021 tax year. Even with the penalty relief, we recommend all S Corporations and partnerships consider filing an extension to allow sufficient time to accumulate the necessary information to complete these forms.
This tax season, many pass-through entities may be surprised by this new filing requirement. RKL’s international tax experts can help your organization adopt a new reporting and filing process and answer any questions about the schedules. To get started, contact your RKL advisor or use the form below.
