For tax years beginning in 2021, the IRS will require almost all partnerships and S corporations to file new Schedules K-2 and K-3. These new schedules replace and supplement the reporting of foreign items on the Schedule K-1 but in greater detail for each item and in a more standardized format.
These schedules focus on international tax items with the purpose of providing more transparency and clarity for owners of pass-through entities regarding how to calculate and report potential international-related deductions, credits, and other miscellaneous IRS compliance items. Nearly every partnership and S Corp, even those that may be a U.S. domestic entity with no foreign activity or foreign owners, will need to complete the schedules. For example, the entity may still need to report information on Schedules K-2 and K-3 so that the owners can properly calculate items such as the foreign tax credit for individuals or the deduction for foreign-derived intangible income for corporations. Those entities that have actual foreign activity will have more expanded reporting requirements than those with only domestic activity. The schedules contain twelve different sections for information that may need to be reported depending on various factors such as type of owners, type of foreign activities (at both entity and owner levels), and type of foreign investments.
Failure to file complete and accurate Schedules K-2 and K-3 can expose the entity to various penalties that can depend on the number of partners or shareholders the entity has. While the IRS issued Notice 2021-39 to provide penalty relief for filers who may fall short of the new requirements in 2021 the relief is only available to those taxpayers that make a good-faith effort to comply with the new requirements.
These new schedules are based on a continuous and consistent effort by Treasury and the IRS for more detailed, transparent, and annual reporting of international activities and investments in foreign assets and companies.
As always, we are here to help guide our clients through the complex IRS compliance requirements. Please reach out to your Maillie LLP representative for further guidance.