Partnerships with interests in international operations know: navigating international tax requirements and reporting the appropriate share of partner income on a Schedule K-1 was never easy. Tax reform under the law commonly known as the Tax Cuts and Jobs Act (TCJA) didn’t make reporting any easier with its numerous changes to international taxes.
This past summer, the IRS released drafts of two new forms to help organize the types of reporting that partners in partnerships or shareholders of S corporations with international operations need to complete. The forms will be submitted along with the 2021 partnership or S corporation returns and Schedules K-1. Our article highlights some of the key features of the new forms, which are intended to replace items previously reported on lines 16 of Schedule K and Schedules K-1 for partnerships (lines 14 in the case of S-corporations). Schedules K-2 and K-3 will include information on items required by partners to report their share of the partnership or S-corporation’s non-U.S. operations, such as:
- Foreign tax credit and limitation items,
- Foreign-Derived Intangible Income (FDII) deductions,
- Information about partners’ interests in Subpart F income and Global Intangible Low-Tax Income (GILTI) inclusions,
- Passive Foreign Investment Company (PFIC) and Qualifying Electing Fund (QEF) information,
- Income from foreign corporations,
- Distributions from foreign corporations, and other items.
Schedule K-2, Partners’ Distributive Share Items – International
Partnerships with international business operations will use Schedule K-2 to track the total of their international distributive share items. This schedule serves as an extension of Schedule K and helps to organize and substantiate the partnership’s non-U.S. tax items.
Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc. – International
Partners and Shareholders will receive and use Schedule K-3 to report their share of the partnership or S-corporation’s international tax credits, deductions, and income. The form serves as an extension of Schedule K-1 and requires operational information that, prior to the creation of the form, would have been submitted in a long-form, non-standardized format as an attachment to the Schedule K-1.
Private equity and venture capital funds in particular will want to be aware of the changes to their reporting, as their investments are often organized as partnerships and many may also involve interests in foreign operations. Regardless of industry, partnerships should be aware that the Schedules K-2 and K-3 are lengthy (19 and 20 pages, respectively) and detailed. Information on international operations will be required on a country-by-country basis and separate for each category of income.
The team preparing tax returns and Schedules K-1 for your organization can expect that 2021 filings will take more time to complete. New forms often mean that the processes and workpaper templates in place for your firm’s tax reporting may need adjusting to address the information gathering required for the Schedule K-2 and Schedule K-3.
Your organization will also need to evaluate how information gathering will need to be changed in order to accommodate Schedule K-2 or K-3 completion. It will likely require additional communication with filing partners and investors, so your Schedule K-1 preparation schedule should allot time for responses to information requests.
But more information doesn’t necessarily mean more reporting. Not every question on the Schedules will be applicable to your partnership’s situation. The key is that the team preparing your partnership’s schedules will need to know detailed enough information about the partners in order to make that determination. For example, your firm’s preparer would need to know if the partnership has accrued interest or royalties that are eligible for a Section 267A deduction. If it hasn’t, then your partnership can skip that section of the Schedule K-2.
Changes may also make life easier for tiered partnerships, which historically had to manually review Schedule K-1 footnotes to glean the information they need for their reporting.
The IRS knows completion of the new forms will be a challenge for the 2021 tax year. It created penalty relief in IRS Notice 2021-39: so long as taxpayers make an effort to comply with the form completion, they won’t be fined for incomplete or inaccurate information.
It’s best to get the information gathering process started early. Consider plugging the data you have into the new requirements to determine where there are gaps in information. The changes may also allow for more standardized workflows for Schedule K-1 completion, including better information channels between partners and the partnership’s form preparers.
For more information about how this could affect your organization, please contact a member of our team.