The IRS provided transition relief Wednesday under which eligible pass-through entities will not have to file new Schedules K-2 and K-3 for tax year 2021. The relief is outlined in News Release IR-2022-38 and frequently asked questions on the IRS website (“Schedules K2 and K3 Frequently Asked Questions” — see FAQ 15).

Affected partnerships are required to file Schedule K-2, Partners’ Distributive Share Items — International, and K-3, Partner’s Share of Income, Deductions, Credits, etc. — International, with their Form 1065, U.S. Return of Partnership Income. The corresponding forms for S corporations to file with their Form 1120-S, U.S. Income Tax Return for an S Corporation, are K-2, Shareholders’ Pro Rata Share Items — International, and K-3, Shareholder’s Share of Income, Deductions, Credits, etc. — International.

The schedules, new for tax year 2021, have been the subject of widespread commentary among tax practitioners in the current return filing season, most of it unfavorable. They must be filed by partnerships, S corporations, and filers of Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships, with “items of international tax relevance,” according to their instructions. The potentially wide reach of that rubric and difficulties inherent in finding and documenting those items have been the focus of much of the practitioners’ expressed frustration.

The schedules are intended to make those international items less obscure for partners and shareholders needing the information to file their own returns. In stating that aim, the IRS has previously acknowledged the administrative burden the schedules impose and provided some transition relief last June, in Notice 2021-39.

The relief announced Wednesday applies where:

• In tax year 2021, the direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts.
• In tax year 2021, the domestic partnership or S corporation has no foreign activity, including foreign taxes paid or accrued or ownership of assets that generate, have generated, or may reasonably be expected to generate foreign-source income (see Regs. Sec. 1.861-9(g)(3)).
• In tax year 2020, the domestic partnership or S corporation did not provide to its partners or shareholders, nor did the partners or shareholders request, the information on the form or its attachments regarding:
  • Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S), and
  • Line 20c, Form 1065, Schedules K and K-1 (controlled foreign corporations, passive foreign investment companies, 1120-F, Sec. 250, Sec. 864(c)(8), Sec. 721(c) partnerships, and Sec. 7874) (line 17d for Form 1120-S).
• The domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting such information for tax year 2021.

AICPA members can get the latest guidance and download a client letter in the IRS Schedules K-2 and K-3 guidance and resources library, compliments of the Tax Section.

The IRS said earlier it was taking the step “in response to feedback we received from the tax community and our stakeholders.”