The IRS recently issued draft tax year 2022 instructions for Schedules K-2/K-3 for both Form 1065 (U.S. Return of Partnership Income) and Form 1120-S (U.S. Income Tax Return for an S Corporation). The draft instructions contain an expanded “Who Must File” section that includes limited relief for domestic partnerships and S corporations (pass-through entities or PTEs) with no foreign activities, assets, partners or taxes under a new “domestic filing exception.” In the absence of meeting this new filing exception, certain “domestic only” pass-through entities with no foreign activity, partners or assets may still need to report information in relevant parts on Schedules K-2 and K-3. For example, partnerships with corporate partners that need information to calculate base erosion and anti-abuse tax (BEAT) and foreign-derived intangible income (FDII) amounts would not meet the domestic filing exception.
The instructions include an exception to Schedules K-2 and K-3 filing with the IRS if all the following conditions (described in more detail below) of the new domestic filing exception are met:
1. The domestic PTE has no or certain prescribed limited foreign activity;
2. All partners or shareholders are U.S. citizens or resident aliens, domestic decedent estates or certain domestic trusts;
3. The domestic PTE sends specific notification to the partners or S corporation shareholders by two months before its filing deadline, without extensions; and
4. No partners or S corporation shareholders explicitly request Schedule K-3 from the domestic PTE prior to one month before the entity's filing deadline, without extensions (Feb. 15 for calendar-year pass-through entities). If the information is requested after Feb. 15, then the PTE only has to provide the information to the requesting partner or S corporation shareholder but does not have to file the Schedules K-2 and K-3 with the IRS.
For tax year 2022 calendar-year PTEs, the “two-month date” is Sunday, Jan. 15, 2023. The following Monday is a legal holiday. Presumably, this will make the deadline Jan. 17. However, we recommend getting notices out as soon as practical before Jan. 15.
If a domestic PTE does not meet the domestic filing exception, it may meet the Form 1116 exemption to filing the Schedules K-2 and K-3.
Schedules K-2 and K-3 were new for the 2021 tax year and are applicable to Forms 1065, 1120-S and 8865. The schedules are generally required to be completed by partnerships and S corporations with “items of international tax relevance,” which the IRS generally describes as international activities and/or foreign partners.
To learn more about how Schedules K-2 and K-3 may impact your tax return filings, please contact your Baker Tilly advisor.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.