There are new tax filing requirements for many pass-through businesses for this tax season.
For tax years beginning in 2021, S corporations and partnerships must file Schedule K-2 and Schedule K-3 if the business has relevant international tax items.
The new schedules are intended to provide more transparency and clarity for the owners of pass-through businesses regarding how to calculate their U.S. income tax liability from relevant international items. The IRS designed these specific schedules to replace the current Schedule K-1 reporting for these items so that the information provided to owners is delivered in a standard format with an additional level of detail.
We’re finding more pass-through businesses are affected by these new filing requirements than you’d expect. Even if your business entity doesn’t have any foreign transactions or income, if any of the business owners do, you have to file the schedules.
Many of our pass-through business clients have to file the schedules because of foreign income or foreign tax credits they have as part of their investment accounts. Pass-through business entities will also need to file these new schedules if any of the owners have foreign tax credits on their individual tax returns and need to file Form 1116.
In an effort to ease this transition and the uncertainty around penalties, the IRS issued guidance confirming it will provide certain penalty relief to filers who fall short of the new requirements in tax years that begin in 2021, so long as taxpayers make a good-faith effort to comply.
The IRS also issued frequently asked questions, which were updated to include the following exceptions and should apply to some pass-through businesses with domestic operations. This guidance is from FAQ No. 15:
- 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.
These new schedules are significant (in some cases exceeding 19 pages), especially if there are foreign partners or foreign operations. Schedule K-3 may also include information not previously reported on Schedule K-1 that could lead to additional filing requirements.
Have questions about whether you and/or your business are subject to these new requirements? Contact us for a personalized assessment.
