New K-2s and K-3s: partial relief for some, burdens and delays for others

Effective for the 2021 tax year, pass-through entities with “items of international tax relevance” are required to file two new forms: 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). For this purpose, “international relevance” is far more expansive than expected and potentially applies to pass-through entities with U.S.-only operations. The IRS is both expanding and standardizing international reporting with the adoption of these new schedules, providing pass-through owners with more detailed information necessary to complete their returns with respect to international tax items.

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  

This tax alert addresses a temporary reprieve from the expanded filing requirement for qualifying pass-through entities as well as delays the IRS is experiencing with electronically accepting these new forms.

Background

In the summer of 2021, the IRS released draft Schedules K-2 and K-3, which limited reporting requirements to pass-through entities with “items of international tax relevance,” generally defined as entities with foreign activities and/or foreign owners. This development was covered in the U.S. international tax and transfer pricing update in our 2021 year-end tax letter.

On Jan. 18, 2022, the IRS released final instructions for Schedules K-2 and K-3 containing extremely broad filing requirements, capturing many pass-through entities with no apparent “items of international tax relevance” — broadly meaning no foreign activities (e.g., no foreign investments, no foreign source income, no assets generating foreign source income and no foreign taxes paid or accrued)