Fernway DiarySM

Nov 03, 2021

Earlier this year, the IRS released final versions of two new schedules for pass-through entity returns.

The new Schedule K-2 and Schedule K-3 will need to be included with Form 1065 for partnerships and Form 1120S for S corporations with international-related deductions, tax credits, and miscellaneous items.

What are the New Schedules K-2 and K-3?

Schedule K-2, Partners’ Distributive Share Items – International is designed to replace and supplement the information formerly included on Line 16 of Schedule K and Schedule K-1. The form will be attached to the pass-through entity’s tax return.

Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc. — International requires the pass-through to report each partner or shareholder’s portion of the items included on Schedule K-2. The new form will be provided to each partner or shareholder along with their K-1. The form will be needed to report their share of each item, such as the Foreign Tax Credit or indirect ownership in a passive foreign investment company on their individual tax return.

Both forms will need to be filed with 2021 partnership and S corporation returns (tax returns filed in 2022).

Schedule K-2 and Schedule K-3 Filing Challenges

Combined, these schedules add dozens of pages of additional informational reporting for entities with international transactions.

Much of the information on these forms was already required to be included on the previous Schedule K-1 but may have been buried in footnotes attached to Schedule K-1. The new schedules are designed to present that information more clearly and in a standardized format, but they require more detailed reporting. As a result, many small entities may have trouble with the record-keeping requirements and obtaining all the required information.

Recognizing that these detailed new schedules will create transitional challenges for many taxpayers, the IRS announced in Notice 2021-39 that it will provide penalty relief for incorrect or incomplete reporting on Schedules K-2 and K-3 for the 2021 tax year, as long as the filer make a good-faith effort to comply.

Factors that the IRS will take into account when deciding whether the company made a good-faith effort to comply with the new reporting requirements include:

• Whether the company made changes to its systems, processes, and procedures for collecting and processing information related to filing Schedules K-2 and K-3
• Whether the company obtained information from partners, shareholders or a controlled foreign partnership or applied reasonable assumptions when information wasn’t available
• Whether the company modified the partnership or S corporation agreement to facilitate sharing relevant information with partners and shareholders

For impacted pass-through organizations and shareholders, it’s a good idea to look at the information required on these new schedules to determine how they might begin gathering the requested information. If you need assistance, please contact your US advisory team at youradvisor@fernwaysolutions.com or visit us at www.fernwaysolutions.com.

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