On February 16, 2022, the IRS published a frequently asked questions (FAQ) page regarding Schedule K-2/K-3 reporting. We noted in a prior BKD Thoughtware® article that the IRS clarified that Schedules K-2/K-3 may be required for domestic partnerships and S corporations that do not have foreign activity or foreign owners, as indicated by the IRS in the schedule instructions.
However, in question 15 of the FAQ, the IRS is providing an exception for the 2021 filing year for certain domestic partnerships and S corps. To qualify for the exception from filing, the following must be met:
- In tax year 2021, the direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts.
- In tax year 2021, the domestic partnership or S corp has no foreign activity, including foreign taxes paid or accrued or ownership of assets that generate, have generated, or may reasonably expect to generate foreign source income (see section 1.861-9(g)(3)).
- In tax year 2020, the domestic partnership or S corp did not provide to its partners or shareholders nor did the partners or shareholders request the information regarding (on the form or attachments thereto):
- Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S), and
- Line 20c, Form 1065, Schedules K and K-1 (Controlled Foreign Corporations, Passive Foreign Investment Companies, 1120-F, section 250, section 864(c)(8), section 721(c) partnerships, and section 7874) (line 17d for Form 1120-S).
- The domestic partnership or S corp has no knowledge that the partners or shareholders are requesting such information for tax year 2021.
If a partnership or S corp qualifies for this exception, the domestic partnership or S corp does not need to file Schedules K-2 and K-3 with the IRS or with its partners or shareholders. However, if the partnership or S corp is subsequently notified by a partner or shareholder that all or part of the information contained on Schedule K-3 is needed to complete their tax return, then the partnership or S corp must provide the information to the partner or shareholder. If a partner or shareholder notifies the partnership or S corp before the partnership or S corp files its return, the conditions for the exception are not met and the partnership or S corp must provide the Schedule K-3 to the partner or shareholder and file the Schedules K-2 and K-3 with the IRS.
Given the timing, we anticipate this to be welcomed relief for a number of taxpayers that were unsure whether Schedules K-2/K-3 are required, along with a reduced burden for those that clearly met the exceptions.
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