Many partnerships and S corporations may have noticed their 2021 income tax returns included considerably more pages than in prior years. This was in large part due to the new Schedule K-2 and Schedule K-3 filing requirements for pass-through entities that were effective for 2021 tax returns.
These schedules are used to report the pass-through entity’s items of international tax relevance, with Schedule K-2 being filed by pass-through entities reporting the pass-through’s total activity, and Schedule K-3 being provided to the owners with their share of the pass-through entity’s activity.
Many pass-through entities were surprised to learn that even though their entity did not have any foreign activity (or very limited activity), they still had to file Schedule K-2 and Schedule K-3 to report certain domestic information that may be applicable to their owners. As a result, the IRS issued guidance in February 2022 providing filing exceptions for 2021 Schedule K-2 and K-3 forms. These exceptions were welcome news for taxpayers and tax return preparers but understood to only apply for 2021 returns.
2022 Schedule K-2 & Schedule K-3 Domestic Filing Exception
On October 25, 2022, the IRS released draft Schedule K-2 and Schedule K-3 form instructions for partnerships filing Form 1065 (see further below for applicability to S corps). While there were several updates for 2022, one significant change was to include a new domestic filing exception. To qualify for the Schedule K-2 and Schedule K-3 filing exception, domestic partnerships must meet all four of the following requirements:
- The domestic partnership must have no or limited foreign activity (see below).
- All direct partners in the domestic partnership for the 2022 tax year are:
- Individuals who are U.S. citizens and/or resident aliens
- Domestic decedent’s estates that are not foreign estates, with solely U.S. citizen and/or resident alien individual beneficiaries,
- Domestic grantor trusts that are not foreign trusts, with solely U.S. citizen and/or resident alien individual grantors and beneficiaries, or
- Domestic non-grantor trusts that are not foreign trusts, with solely U.S. citizen and/or resident alien individual beneficiaries
- The partnership must notify all partners that it meets criteria 1 and 2 and will not be providing Schedule K-3 to the partners unless the partner requests the schedule. Partners must be notified no later than two months before the due date (without extension) for the filing of the partnership’s 2022 Form 1065. Forvis Mazars or submit the Contact Us form below.
Click here to read the latest IRS updates regarding the Schedule K-2/K-3 domestic filing exception.