Over the last few decades, the foreign affairs of U.S. citizens have come under increasing levels of government scrutiny. On November 4, 2022, the IRS issued a new draft set of instructions for an S-corporation’s 2022 Schedules K-2 and K-3; instructions for partnerships followed on December 23, 2022. The IRS finalized these instructions for 2022 on December 23, 2022. While some Partnerships and S-Corporations were spared from filing Schedule K-2 and K-3 forms in 2021, the new guidance implies that most organizations will need to become familiar with the forms for the 2022 tax year. This article summarizes the forms’ new exceptions and what they mean for your organization.
|– In 2021, many Partnerships and S-corporations fell under exceptions provided by the IRS and were not required to file Schedules K-2 and K-3|
– The instructions for 2022 narrow the list of exceptions
– In 2022, many entities will not qualify for an exception and must file Schedules K-2 and K-
What is the purpose of Schedules K-2 and K-3?
The new schedules K-2 and K-3 are intended to improve reporting by standardizing international tax information for business partners and flow-through investors.
- Schedule K-2: Reports an entity’s items of international tax relevance
- Schedule K-3: Reports each partner’s distributive share of items reported on Schedule K-2
What if I don’t have international tax items to report?
Unfortunately, given the newly narrowed exceptions to these forms, you’ll probably still have a filing obligation. Even if your Partnership or S-corporation has no assets generating foreign source income, no foreign source income, no foreign partners (S-corps cannot have foreign shareholders), and no foreign taxes paid or accrued, you may still need to report information on Schedules K-2 and K-3. Ultimately, if your entity doesn’t meet exception criteria, you’ll need to file Schedule K-2 and K-3 with your 2022 Partnership or S-corporation return.
Who is required to file K-2 and K-3?
Any Partnership or S-corp required to file Form 1065 or 1120-S that has items relevant to the determination of the U.S. tax, or certain withholding tax, or reporting obligations of its partners/shareholders under the international provisions of the Internal Revenue Code, is required to file Schedules K-2 and K-3.
What are the exceptions to filling in K-2 and K-3?
- The Domestic Filing Exception
- Form 1116 Exemption Exception
Let’s look at each of these exceptions in more detail.
Domestic Filing Exception
To qualify for the domestic filing exception (DFE), your entity must meet all of the four criteria below:
- No or limited foreign activity, and
- All U.S. partners are citizens or resident aliens, and
- Criteria 1 and 2 are satisfied, and partners receive notification with the issuance of K-1 that partners will not receive Schedule K-3 unless the partners request the schedule, and
- The Partnership does not receive a request from any partner for Schedule K-Partnership, and does not receive a request from any partner for Schedule K- 3 information on or before one month prior to date the Partnership files Form 1065.
Partnerships with Corporate or partnership partners can’t use the Domestic Filing Exception and will therefore be required to file Schedules K-2 and K-3.
To qualify for domestic qualifying exception, your entity must meet all of the three criteria below:
- None or limited foreign activity, and
- Criterion 1 is met and shareholders receive notification with the issuance that shareholders will not receive Schedule K-3 unless the shareholders request the schedule, and
- The S-corporation does not receive a request from any shareholder for Schedule K- 3 information on or before one month prior to date the S-corp files Form 1120-S.
The S-corporation is required to provide the tax year 2022 Schedule K-3 and requested information to the requesting shareholder on the later of:
- Date on which the S-corporation files the Form 1120-S
- OR one month from the date on which the S-corporation receives the request from the shareholder.
Form 1116 Exemption Exception
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.
An 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 one month before the due date (including extensions) of the tax return.
If notification was not received on or before the one-month date, you’ll need to prepare and file Schedule K-2 and K-3.
Need a knowledgeable CPA to help?
We get it—you have a business to run, and it’s not always possible (or the best use of your limited time) to stay up to date with changing tax regulations. We recommend working with a professional 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 Financial Solution Advisors, PLLC for assistance.