Key insights
- Partnerships and S corporations use Schedule K-2 to report partners’ or shareholders’ total distributive share of items with international relevance, including U.S. source income.
- Any entity filing Schedule K-2 must provide a Schedule K-3 to its partners or shareholders according to the timeline for providing the Schedule K-1.
- Although these schedules largely focus on international tax items, they must be populated in purely domestic operating situations if any partners or shareholders are eligible to claim a foreign tax credit.
- Partners and shareholders who do not receive Schedule K-3 with their Schedule K-1 should request it be provided to them.
Get help with Schedules K-2 and K-3.
Many people perceive K-2 and K-3 reporting matters as mainly a global tax issue. However, nearly every pass-through entity client we serve is affected — including domestic organizations with no foreign activity. We see particular application in the private equity, real estate, and manufacturing space.
Take time to understand the reporting now, to help avoid filing delays and understand the complexities and potential cost differentials.
The details
Effective for tax years beginning in 2021, the IRS will generally require new Schedules K-2 and K-3 for persons filing Forms 1065, 8865, and 1120-S. Partnerships and S corporations are to use Schedule K-2 to report partners’ or shareholders’ total distributive share of items, whereas Schedule K-3 is designed to provide each specific partner’s or shareholder’s allocable share of the items reported on Schedule K-2.
Schedule K-2 should be attached to and filed with Forms 1065, 1120-S, and 8865. Any entity filing Schedule K-2 must provide a Schedule K-3 to its partners or shareholders according to the timeline for providing the Schedule K-1. (These new requirements do not replace the requirement to provide Schedule K-1.)
While these schedules are largely focused on international tax items, they are also required to be populated in purely domestic operating situations. This increased reporting provides information around category and source of income to help partners and shareholders correctly calculate foreign tax credits.
In addition to sourcing, the new schedules will provide detailed information to better facilitate the preparation of Form 5471 (Controlled Foreign Corporations), Form 8621 (Passive Foreign Investment Companies), Form 8991 (Base Erosion Payments), and Form 8993 (Foreign-Derived Intangible Income).
Failure to file complete and accurate Schedules K-2 and K-3 can trigger various penalties that can depend on the number of partners or shareholders the entity has.
What does this mean for me?
Part of the new reporting will require documentation about partners’ or shareholders’ residence or country of organization. Partners and shareholders may be asked to provide Form W-9 or Form W-8 to certify their status as either domestic or foreign partners or shareholders. Failure to provide this information can create additional reporting requirements for the partnerships and S corporations completing the schedules.
If you do not receive a Schedule K-3, you should request it from your Schedule K-1 provider.
How we can help
These new schedules are significant (in some cases exceeding 19 pages), especially if there are foreign partners or foreign operations. Schedule K-3 may also include information not previously reported on Schedule K-1 that could lead to additional filing requirements. Once received, discuss with your tax advisor to determine the impact to your personal return.
With these new partnership tax filing requirements, you may also be eligible for penalty relief. For more details, visit the IRS website answering frequently asked questions about Schedules K-2 and K-3.