On February 16, the IRS issued additional relief for certain pass-through entities required to file new Schedules K-2 and K-3, along with a set of “Frequently Asked Questions.” The relief is outlined in News Release IR-2022-38 and Schedules K-2 and K-3 Frequently Asked Questions (Forms 1065, 1120S, and 8865).
The additional relief came in response to widespread criticism from tax return preparers and taxpayers over onerous assumptions that the IRS originally required many filers to make. Under the new relief, certain partnerships and S corporations will not need to file the new Schedules K-2 and K-3 for 2021.
For partnerships and S corporations that still need to file Schedules K-2 and K-3, IRS Notice 2021-39 (released in June 2021) provides penalty relief for incorrect or incomplete reporting on Schedules K-2 and K-3 “if the filer establishes to the satisfaction of the Commissioner that it made a good faith effort to comply with the new reporting requirements.” For instance, filers still need to complete Schedules K-2 and K3 when they are not eligible for the exception under the February 2022 IRS guidance.
in order to qualify for the exception, the IRS states that the following conditions 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.
- The domestic partnership or S corporation has no foreign activity, including foreign taxes paid or accrued or ownership of assets that generate, have generated, or may reasonably be expected to generate foreign-source income (refer to Section 1.861-9(g)(3)).
- The domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting information regarding:
- 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).
In Tax Year 2020
- The domestic partnership or S corporation did not provide to its partners or shareholders, nor did the partners or shareholders request, the information on the form or its attachments regarding:
- 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).
Certain domestic partnerships and S corporations that meet these criteria are not required to file Schedules K-2 and K-3. However, there is an important stipulation to keep in mind. If a partner or shareholder subsequently notifies the partnership or S corporation that all or part of the information included on Schedule K-3 is required to complete their tax return, then the partnership or S corporation must provide the information to the partner or shareholder.
Remember that one of the criteria for the exception is that the partnership or S corporation did not report certain information during 2020, such as Foreign Tax Credit (FTC) information. For example, simply reporting FTC information during 2020 will make the entire exception unavailable for 2021. This would mean that the partnership or S corporation is still subject to the 2021 requirement that it “must presume” for each of Parts II, III, IV, VIII, and X of Schedules K-2 and K-3 that they are required, unless it obtains sufficient information for each part that such part is not required.
Partnerships in certain industries, such as private equity and GP entities, may generally find that filing relief is of a little value, as the sophisticated tax situation of their investors and sponsors will typically require the disclosure of information necessary for their calculation of FTCs.
Currently, this exception only applies to 2021 tax returns. We will keep you up-to-date on any new developments as it relates to Schedules K-2 and K-3.
For more information on how this may impact you, please contact your tax advisor.
Published on April 05, 2022
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