The IRS recently revised, again, draft 2022 instructions for Schedules K-2/K-3 for partnerships and S corporations; further modifying relief for certain domestic partnerships and S corporations (pass-through entities or PTEs) that meet certain criteria, including limited or no foreign activities and qualifying partners and shareholders. This alert modifies our previous alert, Draft Schedule K-2/K-3 instructions provide limited relief.
The updated draft instructions for Schedules K-2/K-3 include a modified domestic filing exception for pass-through entities meeting all of the conditions below:
1) No or limited foreign activity. The domestic pass-through entity has no or certain prescribed limited foreign activity. Foreign activity is defined as: (a) foreign income taxes paid or accrued; (b) foreign source income or loss; (c) ownership interest in a foreign partnership; (d) ownership interest in a foreign corporation; (e) ownership of a foreign branch; (f) ownership interest in a foreign entity that is treated as disregarded as an entity separate from its owner. This condition has not changed since the first set of draft instructions.
2) U.S. citizen/resident alien owners. All partners and S corporation shareholders are U.S. citizens or resident aliens, domestic decedent estates or certain domestic trusts. However, the updated draft instructions now permit additional direct owners to include S corporations with a sole shareholder or a single member limited liability company (LLC), where the LLC’s sole member is a permissible owner and the LLC is disregarded as an entity separate from its owner for federal tax purposes. This condition has changed since the first set of draft instructions.
3) Partner and S corporation shareholder notification. If criteria Nos. 1 and 2 are satisfied, partner and S corporation shareholder notifications can be attached to Schedule K-1 when provided to the partners and S corporation shareholders. The notification must state the partners or S corporation shareholders will not receive Schedule K-3 from the pass-through entity unless specifically requested. This condition has changed since the first set of draft instructions. The separate “two-month date” notification is no longer required.
4) No 2022 Schedule K-3 requests by the one-month date. The pass-through entity does not receive a request by any partner or S corporation shareholder for Schedule K-3 on or before the one-month date, which is one month before the filing of Forms 1065 or 1120S. The latest possible one-month date for 2022 calendar-year PTE returns is Aug. 15, 2023 (if the pass-through entity files an extension). If the PTE receives a request for Schedule K-3 from a partner or S corporation shareholder after the one-month date and has not received such a request from any other partner or S corporation shareholder on or before the one-month date, the domestic filing exception is met and the PTE is not required to file Schedules K-2/K-3 with the IRS or furnish Schedule K-3 to the nonrequesting partners or S corporation shareholders. If a partner or S corporation shareholder does make a timely request, Schedule K-3 must be furnished to the requesting parties by the later of the filing of Forms 1065 or 1120S or one month from the request. This condition has changed since the first set of draft instructions.
Keep in mind this alert is reporting on draft instructions released by the IRS and the information contained herein is subject to change.
Please reach out to your Baker Tilly advisor if you have questions regarding your tax position.
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.