There are new and onerous IRS filing requirements dealing with the reporting of certain foreign transactions. These requirements will impact many of our client’s partnership and S-corporate income tax returns for 2021 and going forward. These filings may be required, even if the entity does not in itself have any foreign transactions. A very common tax credit, which many of our clients qualify for, is a foreign tax credit (claimed on IRS form 1116). The information needed to claim the credit is provided to you on your year-end brokerage tax statements. If any members or shareholders of an entity claim this foreign tax credit as part of their personal income tax return, the business entity may be required to comply with these new regulations and reporting requirements.

Commencing with the 2021 business entity tax returns we may be reaching out to you and other members/shareholders of your business entity to inquire if any have filed, or expect to file, the form 1116 as part of your individual income tax returns. If members/shareholders have not, or do not expect to file this form we may be requesting that the members/shareholders send us a statement to that effect.

Key Takeaways:

  • Schedule K-2/K-3 must be filed by all pass-through entities with items of “international tax relevance”, including entities with foreign partners and international transactions.
  • Schedule K-2 is an extension of Schedule K of the 1065/1120-S and Schedule K-3 is an extension of Schedule K-1.
  • The partnership must assume the forms will be needed and must file the K-2/K-3, unless the partners inform the partnership that the information is not needed.
  • IRS has provided certain additional transition relief for the 2021 tax year for pass-through entities with no foreign activities, foreign partners/shareholders, and other items of international tax relevance.

For those of you who enjoy reading an enhanced technical summary, please keep reading….

Introduction:

Beginning with the 2021 tax year, pass-through entities with “international tax relevance” will be required to include the new schedules K-2/K-3 with their returns. These forms are essentially an extension of the information that was previously reported on the “foreign transactions” section of the K-1 on the 1065/1120-S (box 16 and 14 respectively). These forms will also include information from the collection of international footnotes and statements that was previously attached to the K-1. This information will now be in a standardized format included within the K-3.

What are items of “international tax relevance”:

Although there is no clear definition of what an item of international tax relevance is, the instructions for the forms reference various international provisions of the Internal Revenue Code. Examples of such items to be reported include, but are not limited to:

  • Foreign Tax Credit and related information
  • Interest in foreign entities and/or distributions from foreign corporations
  • Foreign partners US source income and/or US effectively connected income
  • Information relating to investments in foreign entities
  • GILTI and Subpart F income inclusions from interest in controlled foreign corporations
  • Foreign-derived intangible income
  • Information relating to Passive Foreign Investment Companies (or “PFICs”)

Conclusion:

Pass-through entities should prepare for the 2021 tax season by reviewing their 2021 transactions to determine whether a filing requirement would apply for the entity. Pass-through entities should ensure that their partners are properly documented with a W-8 or a W-9 form as this will help in determining whether a filing is required. While these new K-2/K-3 Schedules will be a compliance burden for most pass-through entities, they will help pass-through entities’ owners with respect to international transactions and foreign reporting.

If you have any questions or concerns regarding the Schedule K-2/K-3 filing requirements, or if you have any questions about how these forms will affect your tax filing, please do not hesitate to contact us. We will continue to keep you informed as additional guidance is issued on the forms and filing requirements.

The IRS has posted a series of 26 FAQs that provide some guidance on the limited relief to the new Schedule K-2/K-3 filing requirements beginning with the 2021 tax year. Transition relief from filing these forms for 2021 is granted if the following situations are met:

  • The entity has no foreign partners/shareholders
  • The entity has no foreign activity (including foreign taxes, foreign sourced income, and foreign assets that generate income)
  • The entity has no knowledge that the partners/shareholders are requesting such information for tax year 2021

The following links will provide additional information regarding the K-2/K-3:

https://www.irs.gov/businesses/schedules-k-2-and-k-3-frequently-asked-questions-forms-1065-1120s-and-8865

https://www.irs.gov/pub/irs-pdf/i1065s23.pdf

https://www.irs.gov/pub/irs-pdf/i1120s23.pdf

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