New Reporting Requirement for Schedule K-2 and K-3 Affecting Pass-Through Entities

LGA wants to inform our clients about a significant change made by the IRS that will affect a majority of pass-through entities. New this year, IRS Schedules K-2 and K-3 will need to be completed to include items of international tax relevance from the operations of a pass-through entity. If any of the owners have foreign tax credits, the pass-through entity may have a reporting requirement, even if they are a completely domestic operation.

What Has Changed?

If a pass-through entity has any international activity it will be required to report on these new schedules if it files:

• Form 1065, U.S. Return of Partnership Income
• Form 1120-S, U.S. Income Tax Return for an S Corporation
• Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships

Schedules K-2 and K-3 replace, supplement, and clarify the reporting of certain amounts formerly reported on a partner’s or shareholder’s Schedule K-1 as foreign transactions.

Why Were These Changes Made?

The new standardized format assists pass-through entities in providing partners or shareholders with the information necessary to complete their returns with respect to international tax aspects. It also allows the IRS to verify tax compliance more efficiently, although it makes it a more time-intensive reporting requirement.

What Happens With Non-compliance?

Failure to file such forms or properly provide these information statements to partners or shareholders can result in significant penalties.

What Do We Advise LGA Clients?

These new schedules are longer and will require additional time to complete. In addition, the IRS and software providers have not finalized the forms or electronic filing processes. Therefore, an extension may be required to allow us to complete your returns accurately. Because of these new rules and delays with the IRS accepting these schedules for electronically filed returns, we advise clients not to delay sending us their information.

There are nuances to the reporting requirements, such as potentially determining whether each partner’s or shareholder’s respective income tax returns contain Form 1116, Foreign Tax Credit, or other international tax forms. If applicable, the pass-through entity may be required to file Schedules K-2 and K-3.

The IRS has provided some transitional relief that may apply to your business for the 2021 tax year. We can help you determine if the exception to the reporting requirements applies to you. However, it is worth noting that this exception is for 2021 only, and more pass-through entities will be required to file these forms in 2022.

We understand that you may have questions or concerns about this new reporting requirement. Our team members are available to answer all questions you may have and can assist you with all of your tax and financial planning needs. If you have any questions, please contact your LGA Advisor or call us at 781-569-4700.