Beginning with the 2021 tax filings, Schedules K-2 and K-3 are now required for partnerships with relevant international tax items. The new schedules 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. Much of the information required by the new schedules was already required in the past by Schedules K and K-1. However, the new schedules require a more detailed level of reporting which adds to the complexity of tax compliance for partnerships engaged in international activities or with foreign partners.
A partnership needs to complete Schedules K-2 and K-3 if the partnership has items of international tax relevance. Relevant items include international income, deductions, credits, foreign partners, and other tax or reporting obligations of partners under the international provisions of the Internal Revenue Code. A partnership should reference each part and section of the schedules to determine their specific filing requirements. A partnership is only required to complete the relevant portions of Schedules K-2 and K-3, so each partnership will include varying amounts of information on the schedules depending on their circumstances.
Because of the increased detail and complexity required by the new schedules, the IRS released Notice 2021-39 which provides transition period penalty relief for Schedules K-2 and K-3. However, a filer will not automatically qualify for penalty relief without making a good faith effort to obtain all required information. To determine a “good faith effort,” the IRS will consider the extent to which a Schedule K-2/K-3 filer has made changes to its systems, processes, and procedures for collecting and processing information relevant to filing. The IRS will also look at the steps a filer takes to modify its partnership agreements or other governing documents to facilitate the information sharing with partners that is relevant to filing the new schedules.
While the intention behind the forms makes sense, it is just one more item related to international taxation that has become more burdensome and complicated.
