Updated 1/18/2023 to reflect the latest guidance.
While some partnerships and corporations were spared from filing the Schedule K-2 and K-3 forms in 2021, new guidance implies your organization will need to become familiar with the forms for 2022. Below, we discuss the forms’ new, narrower exceptions and what they mean for your organization.
What is the Purpose of These Forms?
Schedule K-2 reports items of international tax relevance for the entity. Schedule K-3 reports the partner’s distributive share of items reported on Schedule K-2. You may feel a sense of relief if there are no international tax items in your entity. Unfortunately, given the narrow exceptions to these forms, this likely does not factor into whether you have a filing obligation.
There are two exceptions to filing these forms: 1) Domestic Filing Exception or 2) Form 1116 Exemption Exception. If an exception is not met, Schedule K-2 and K-3 must be filed with the 2022 Partnership or S-Corporation return.
Domestic Filing Exception
The entity must meet each of the four criteria below to qualify for domestic qualifying exception:
No or Limited Foreign Activity:
Limited foreign activity is passive, reported on a payee statement (Form 1099, Schedule K-1, etc.), and the foreign taxes for the partnership/S-corporation must be $300 or less
US Citizen/Resident Alien Partner Test
Qualifications are defined as:
- individuals that are U.S. citizens
- individuals that are resident aliens
- domestic decedent’s estates
- domestic grantor trusts
- domestic non-grantor trusts
- S-Corporations with a sole shareholder
- Single member LLC’s whose owner is one of the persons in noted above in 1-6.
Partnerships with Corporate or Partnership partners CANNOT use the Domestic Filing Exception and thus will be required to file Schedules K-2 and K-3.
Partner/Shareholder Notification Requirement:
The entity must provide notification to all partners/shareholders no later than the date the Schedules K-1 are provided. The notice can be provided as an attachment to the Schedule K-1. The notification must state that partners/shareholders will not receive Schedule K-3 from the partnership/S-corporation unless requested.
Partner/Shareholder Request Received by the “1-Month Date”:
The entity does not receive a request from any partner/shareholder for Schedule K-3 information on, or before, the 1-month date. The “1-Month Date” is one month before the due date (including extension) of the tax return.
If a request is received on or before the “1-Month Date”, the Schedule K-2 and K-3 is only required to be prepared and filed with the IRS for the partners requesting the Schedule K-3 information.
If a request is received after the “1-Month Date,” the domestic filing exception is met and the entity is not required to file Schedule K-2 and K-3 with the IRS. The entity is required to provide the completed Schedule K-3 to the requesting partner.
The Form 1116 Exemption Exception:
The entity is not required to complete Schedules K-2 and K-3 if all partners/shareholders meet the Form 1116 exemption and the entity receives notification of the partners/shareholders’ eligibility for the exemption by the “1-Month Date,” one month before the due date (including extensions) of the tax return.
The Schedule K-2 and K-3 is only required to be prepared and filed with the IRS for partners/shareholders where notification was not received on or before the “1-month date”
Form 1116 Exemption applies to individual taxpayers whose foreign tax does not exceed $300 ($600 in the case of a joint return) and their entire amount of creditable foreign tax and income is passive and reported on Form 1099, Schedule K-1 or Schedule K-3.
Partnerships with partnership partners can meet the Form 1116 Exemption Exception if all beneficial owners meet the Form 1116 Exemption and notify the entity by the “1-Month Date.”
Key Takeaways
While many Partnerships and S-Corporations fell under exceptions provided by the IRS and were not required to file Schedules K-2 and K-3 in 2021, the instructions for 2022 narrow the list of exceptions. Remember, many Partnerships with Corporate or Partnership partners will not quality for an exception and must file these forms.
As always, we recommend that you work with a knowledgeable CPA to ensure that you are properly filing all necessary forms with the IRS. If you have any questions or need additional information regarding these rules, please contact Clark Nuber.
Co-author Amanda Brault is a principal in Clark Nuber’s Tax Services Group.
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