IRS Lag on Schedules K-2 and K-3 Delays Tax Return Filings for Some Partnerships and S corporations
If you are a partner in a pass-through entity (PTE) with foreign income, you may still be waiting for the necessary income reports to file your 2021 tax returns. The IRS so far has not released instructions on how to prepare the new schedules K-2 and K-3, and until those instructions are released, tax software platforms can’t be programmed to fill out the forms.
This is the major hiccup that has compelled the American Institute of Certified Public Accountants to urge the IRS to postpone the implementation of the K-2 and K-3 schedule requirements. The IRS began requiring completion of schedules K-2 and K-3 for any partnership or S corporation that had items of international tax relevance for the 2021 tax year. However, the IRS announced in December it would not be able to accept such forms until after the due dates for the affected returns.
Schedules K-2 and K-3 supplement the former line 16 on Schedule K of Form 1065, Partner’s Distributive Share Items, Foreign Transactions, as well as line 16, Foreign Transactions, of Schedule K1.
These new schedules provide more detailed information than in the past about foreign-derived income both at the partnership or S corporation level (Schedule K-2) and at the individual partner level (Schedule K-3).
The IRS created schedules K-2 and K-3 in an effort to improve the calculations used for foreign tax credits. Any PTE that may have had foreign business operations and income in the past wasn’t required to disclose it at a detailed level.
Companies with international operations and income pay taxes in foreign countries on income derived from those countries. However, the U.S. tax system is based on worldwide income and, as a result, taxes the same income that is derived from and taxed in other countries. Foreign tax credits enable companies to recoup the equivalent of the U.S. tax they would pay on foreign income.
For example, if a corporation is taxed at 20% in the U.S. and 30% in Switzerland, it will net out at 10% after the foreign tax credit is factored in.
Schedules K-2 and K-3 will disclose information on foreign-derived income to shareholders in more detail. So, when they are determining their own foreign tax credits, they’ll be more accurate. When the shareholder receives a K1, they will learn what their individual share of the corporation’s foreign income is from the K-2 and the K3.
That is, if the IRS can get its act together and issue instructions and guidance to better define how the forms should be prepared.
If your company held an investment account in 2021 that had foreign investments, the new requirement for schedules K-2 and K-3 apply to you.
We’re here to help
We will keep you informed as to when the necessary forms are available and how they are to be prepared. In the meantime, if you have questions about how the Schedule K-2 and Schedule K-3 requirements may affect you or your entity, we can help. Contact your JLK Rosenberger team member or click here to contact us. We look forward to speaking with you soon.