Note: This article was originally published on February 11, 2022. As of February 17, 2022 the IRS has since revised their requirements. Head here for their latest.
It started out as a very simple idea; the IRS was under the impression that flow-through entities weren’t providing their partners/shareholders or the government with sufficiently detailed information on “items of international tax relevance” from their operations. So, they set about to create a new form which would be an extension of the Schedules K and K-1.
On July 14, 2020, draft versions of Schedules K-2 and K-3 were released for comment. Many professional organizations and accounting firms let the IRS know what they thought. (We will refrain from repeating those comments.) Over the next year, multiple updated drafts were released engendering even more comments. Last summer, final versions of the forms and instructions were released. At least we were told they were final.
Initially, the expectation was that only partnerships and S Corporations with foreign activities would have to prepare these forms. As of the latest versions of the instructions released on January 18th, pass-through entities must prepare these forms if they have direct or indirect owners who may be eligible to claim a foreign tax credit. Since not all entities have complete transparency into their indirect owners, the assumption is that virtually every partnership and every S Corporation will have to include these forms with their returns and the K-1s they provide to their owners.
With more parts than a barbershop – Schedule K-2 (also known as Partners’ Distributive Share Items—International) is 19 pages long and Schedule K-3 (called Partner’s Share of Income, Deductions, Credits, etc.—International) runs 20 pages. Even in a tax software environment, much of the information must be input manually. Add to that the fact that the IRS isn’t yet prepared to receive the information electronically and won’t be until sometime this summer so the forms will actually have to be attached to efiled returns as PDFs. On a positive note, the IRS has indicated that it will provide penalty relief to those taxpayers who make a good faith effort to complete the forms.
What do you need to do?
If you are responsible for your partnership or S Corporation’s tax return you can expect to receive requests for more detailed information. You will also need extra time to review a more complex return prior to signing and filing.
If you are a partner or S Corporation shareholder, look forward to receiving a K-1 package that is significantly longer and more complex. Take the time to review it thoroughly. Ask questions. This information is being provided so that you can comply with your own filing requirements.
Understand that the return preparation process – both for the entity and the recipient of the new schedules – has now become both longer and more complex.
Count on Friedman LLP
Your Friedman LLP advisor will keep you updated as these filing requirements evolve, help you determine how to comply with them and resolve any inconsistent guidance. Contact us now with any questions.