Advocacy Update: IRS issues K-2/K-3 filing relief for 2021

February 16, 2022

Updated: Feb. 17, 2022

In response to a call from the FICPA, other state societies and the AICPA’s Foreign Partnership Reporting Task Force, the IRS on Wednesday provided further details on additional transition relief for certain domestic partnerships and S corporations preparing the new schedules K-2 and K-3.

The IRS released the following statement, announcing that "those eligible for the relief will not have to file the new schedules for tax year 2021."

WASHINGTON — The IRS today provided further details on additional transition relief for certain domestic partnerships and S corporations preparing the new schedules K-2 and K-3 to further ease the change to these new schedules. Those eligible for the relief will not have to file the new schedules for tax year 2021.

The new schedules K-2 and K-3 improve reporting by standardizing international tax information to partners and flow-through investors, making it easier for them to report these items on their tax returns. In addition, the changes ease flow-through return preparation compliance by clarifying obligations and standardizing the format for reporting.

Notice 2021-39 PDF provides penalty relief for good-faith efforts to adopt the new schedules. Today's transition relief, appearing in new frequently asked questions (FAQs) on Schedules K-2 and K-3, allows an additional exception for tax year 2021 filing requirements by certain domestic partnerships and S corporations.

The IRS is providing an additional exception for tax year 2021 to filing the Schedules K-2 and K-3 for certain domestic partnerships and S corporations. To qualify for this exception, the following 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.

In tax year 2021, 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 expected to generate foreign source income (see section 1.861-9(g)(3)).

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 regarding (on the form or attachments thereto):
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).

The domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting such information for tax year 2021.

If a partnership or S corporation qualifies for this exception, the domestic partnership or S corporation does not need to file Schedules K-2 and K-3 with the IRS or with its partners or shareholders. However, if the partnership or S corporation is subsequently notified by a partner or shareholder that all or part of the information contained on Schedule K-3 is needed to complete their tax return, then the partnership or S corporation must provide the information to the partner or shareholder. If a partner or shareholder notifies the partnership or S corporation before the partnership or S corporation files its return, the conditions for the exception are not met and the partnership or S corporation must provide the Schedule K-3 to the partner or shareholder and file the Schedules K-2 and K-3 with the IRS.

The IRS welcomes additional comments on Schedules K-2 and K-3. This feedback and inquiries can be sent to [email protected].

The AICPA’s Foreign Partnership Reporting Task Force has been tackling K-2 and K-3 issues and questions since the draft forms were released in 2020 and continues to work on behalf of members and taxpayers to try to streamline the reporting process.

The FICPA will host a Webinar outlining everything you need to know about K-2 and K-3 disclosure requirements this Friday, Feb. 18, from 9-11 a.m.

In this session, we’ll look at the conditions under which these Schedules must be prepared by partnerships and S corporations, as well as steps that can be taken to obtain information from equity holders that may allow the entities to avoid the preparation of the forms. Click here to register.

The AICPA’s Tax Practice & Ethics Team has developed IRS Schedules K-2 and K-3 resources, including:

A Schedules K-2 and K-3 guidance and resources (available to everyone): Access resources to advise clients on Schedules K-2 and K-3, which are used to report items of international tax relevance from the operations of pass-through entities.
And a Schedules K-2 and K-3 Client Information Letter (available to AICPA members): Notify your clients about the new reporting forms and advise them to contact you with questions.

You can also learn more about Schedule K-2 and K-3 concerns via the content linked below.