The brand new and final Schedule K-2, ‘Partners’ Distributive Share Items – International’ and Schedule K-3, ‘Partners’ Share of Income, Deductions, Credits, etc. – International’ were released on June 3 and 4, 2021. These forms will be a part of the Forms 1065, 1120-S, and 8865 for tax year 2021 (the 2022 filing season). The IRS also released draft instructions for the forms on July 9, 2021.
The new schedules range between 15 and 20 pages and are designed to provide greater clarity for partners on how to compute their U.S. income tax liability with respect to items of international tax relevance, including claiming foreign tax credits, GILTI, FDII, etc.
If an entity does not have items of international tax relevance (typically, international activities or foreign partners), the new form will not be required to be filed.
The K-2 will complement the Schedule K, ‘Partners’ Distributive Share Items’, and will report the partnership’s share of the international items. The items on Schedule K-2 will replace the ‘Foreign Transactions’ section on the Schedule K lines 16(a) through 16(r).
The K-3 will complement the Schedule K-1, ‘Partner’s Share of Income, Deductions, Credits, etc.’ and show each partner’s share of the international items. Like the Schedule K-1, each partner will receive their own Schedule K-3 showing their share of the items reported on the Schedule K-2. Schedule K-3 will replace Schedule K-1, Part III, Box 16 (Foreign Transactions) and the international items normally reported on Box 20 (Other Information).
Both new forms will have a similar layout and cover these areas:
· Part I, Partnership’s Other Current Year International Information
· Part II, Foreign Tax Credit Limitation
· Part III, Other Information for Preparation of Form 1116 or 1118
· Part IV, Information on Partners’ Section 250 Deduction With Respect to Foreign-Derived Intangible Income (FDII)
· Part V, Distributions from Foreign Corporations to Partnerships
· Part VI, Information on Partners’ Section 951(a)(1) and Section 951A Inclusions
· Part VII, Information to complete Form 8621
· Part VIII, Partnership’s Interest in Foreign Corporation Income (Section 960)
· Part IX, Partners’ Information for Base Erosion and Anti-Abuse Tax (Section 59A)
· Part X, Foreign Partners’ Character and Source of Income and Deduction
· Part XI, Section 871(m) Covered Partnerships
The IRS goal was to simplify the reporting of the various international tax provisions that were reported on forms not designed for the task. The impact on the average entity tax preparer should be minimal and possibly a welcome change from using the often changing ‘other information’ box. Preparers of partner’s Form 1040s will appreciate receiving the new schedules as it should simplify the transfer from the Schedule Ks to the Form 1040. Tax preparers in the finance industry, for example venture capital or hedge funds, may see this as an increased burden on their already difficult reporting of a global entity.
As is common with new forms, there will be tax preparers unaware of the change or uncertain how to use the form, so the IRS announced on July 1, 2021 a ‘Transition Period Penalty Relief for New Schedules K-2 and K-3’ (Notice 2021-39). Relief from penalties for any incorrect or incomplete reporting on the Schedules K-2 and K-3 will be granted if the filer establishes to the satisfaction of the Commissioner that it made a good faith effort to comply with the new reporting.