Schedules K-2 and K-3 will be a major change to partnership and S corporation reporting starting in 2021 and will be required for 2022 and future years. Schedule K-2 and K-3 are intended to provide greater clarity for partners and shareholders on how to compute their U.S. income tax liability with respect to items of international tax relevance, including claiming deductions and credits.
Any partnership formed outside of the US will be required to provide the forms. However, the IRS has provided transition relief under which eligible passthrough entities will not have to file new Schedules K-2 and K-3. For 2021 tax returns only, the changes do not affect partnerships and S corporations with:
- No foreign activities,
- No foreign partners or shareholders, and,
- No knowledge of partner or shareholder need for information on items of international relevance.
The last point above is cause for concern. If any partner/shareholder claims a credit for foreign taxes paid by filing Form 1116 with their personal tax return, the entity must file Forms K-2 and K-3 should any partner/shareholder ask for the information. When a practitioner can determine with certainty that no Forms 1116 will be filed for partners or shareholders, the new reporting can be avoided for the passthrough entity return.
The CPA community hopes the IRS realizes the unintended consequences this creates for many small businesses. If not, the additional work involved could cause return preparation prices to increase by thirty to fifty percent.
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