New Schedules K-2 & K-3 affecting all flow-through entity tax returns

AAFCPAs would like to make clients aware that the IRS has released final versions of two new Schedules K-2 & K-3 that should be included with tax returns of pass-through entities. These schedules were originally perceived as being required to be filed only by entities reporting items of international relevance.  However, in its recent January update, the IRS made it clear that these schedules will need to be filed by nearly every pass-through entity, including domestic organizations with no foreign activity.

About Schedules K-2 & K-3:

For tax years beginning in 2021, a partnership, an S corporation as well as certain foreign partnerships must file Schedule K-2 – Partners’ Total International Distributive Share of Items, and Schedule K-3 – Partner’s Share of International income, Deductions, Credits and Other Items.  Schedule K-2 summarizes all such activity at the entity level and Schedule K-3 reflects each owner’s allocated share of this activity.

These new schedules are intended to provide more transparency and standardization for the owners of pass-through structures on how to correctly calculate foreign tax credits on their individual income tax returns, Form 1040.

Penalties for non-compliance and relief:

Failure to file complete and accurate Schedules K-2 and K-3 can trigger various penalties that are calculated monthly and can quickly add up for entities with many owners.  Recognizing that the adoption of these new schedules will create many challenges for both the taxpayers as well as tax practitioners, the IRS has provided some transition relief with more guidance and answers to come.

Effect on flow-through owners:

As individual taxpayers, you may be getting a level of detail with your Schedule K-3 that you have not previously seen from your Schedule K-1 provider.  This information will be especially important if you are required to file Form 1116 (Foreign Tax Credit). Owners should expect to receive a Schedule K-3 from an entity that provides you with a Schedule K-1.  AAFCPAs recommends taxpayers inquire about it from your provider. In addition, part of the new reporting will require documentation about owners’ residence or country of organization.  You may be asked to furnish Form W-9 or Form W-8 to determine the status as either domestic or foreign partner or shareholder as well as other applicable information.

AAFCPAs is here to help:

This topic has been getting quite some attention in the news and with the IRS.  These new schedules could be significant in terms of complexity and return preparation time, especially if there are foreign partners or foreign operations.  AAFCPAs can help you navigate the new reporting requirements if you are on the receiving end or providing Schedules K-2 and K-3 to your owners.  AAFCPAs has also been following the IRS penalty relief measures as well as FAQs that have been released and that continue to be updated and developed.  We will continue to follow this evolving topic closely and will provide updates as appropriate.

If you have questions, please contact Bella Amigud, CPA, MST at bamigud@nullaafcpa.com, Richard L. Weiner, CPA, MST at rweiner@nullaafcpa.com; or your AAFCPAs Partner.