Article | Tax alert

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

Feb. 17, 2022 · Authored by Paul Dillon, Michelle Hobbs, James Lawson, Christopher S. Brown

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). Surprisingly, the instructions require entities to complete certain sections of Schedules K-2 and K-3 if the information reported

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