Many people perceive K-2 and K-3 reporting matters as mainly a global tax issue. However, nearly every pass-through entity business is affected — including domestic organizations with no foreign activity. There is particular application in the private equity, real estate, and manufacturing space.
Effective for tax years beginning in 2021, the IRS will generally require new Schedules K-2 and K-3 for persons filing Forms 1065, 8865, and 1120-S. Partnerships and S corporations are to use Schedule K-2 to report partners’ or shareholders’ total distributive share of items, whereas Schedule K-3 is designed to provide each specific partner’s or shareholder’s allocable share of the items reported on Schedule K-2.
Schedule K-2 should be attached to and filed with Forms 1065, 1120-S, and 8865. Any entity filing Schedule K-2 must provide a Schedule K-3 to its partners or shareholders according to the timeline for providing the Schedule K-1. Take note that these new requirements do not replace the obligation to provide Schedule K-1.
While these schedules are largely focused on international tax items, they are also required in purely domestic operating situations. This increased reporting provides information around category and source of income to help partners and shareholders correctly calculate foreign tax credits.
In addition to sourcing, the new schedules will provide detailed information to better facilitate the preparation of Form 5471 (Controlled Foreign Corporations), Form 8621 (Passive Foreign Investment Companies), Form 8991 (Base Erosion Payments), and Form 8993 (Foreign-Derived Intangible Income).
Failure to file complete and accurate Schedules K-2 and K-3 can trigger various penalties that can depend on the number of partners or shareholders in an entity.
Part of the new reporting will require documentation about partners’ or shareholders’ residence or country of organization. Partners and shareholders may be asked to provide Form W-9 or Form W-8 to certify their status as either domestic or foreign partners or shareholders. Failure to provide this information can create additional reporting requirements for the partnerships and S corporations completing the schedules. If you do not receive a Schedule K-3, you should request it from your Schedule K-1 provider.
Take time to understand the reporting now, to help avoid filing delays and understand the complexities and potential cost differentials.
For more information on Schedules K-2 and K-3, contact Kate Shelton at kate.shelton@CLAconnect.com or Kyle Dawley at kyle.dawley@CLAconnect.com. For more information on CliftonLarsonAllen LLP, visit CLAconnect.com.