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Schedules K-2 and K-3 Filing Requirements for 2021: What You Need to Know

The IRS has announced additional filing information for pass-through entities regarding two new tax forms — Schedules K-2 and K-3 — for the 2021 tax year. Schedules K-2 and K-3 replace, supplement and clarify the reporting of certain amounts formerly reported on a partner’s or shareholder’s Schedule K-1 as foreign transactions. The new standardized format assists pass-through entities in providing partners or shareholders with the information necessary to complete their returns with respect to international tax aspects and allows the IRS to verify tax compliance more efficiently.

If the entity has items of international tax relevance, which could be as simple as holding investments that pay foreign taxes, it will be required to report on these new schedules if it files:

  • Form 1065, U.S. Return of Partnership Income
  • Form 1120-S, U.S. Income Tax Return for an S Corporation
  • Form 8865, Return of U.S. Persons with Respect to Certain Foreign Partnerships

There are nuances to the reporting requirements, such as potentially determining whether knowledge exists in relation to each partner’s or shareholder’s respective income tax returns and for instance, Form 1116, (Foreign Tax Credit) or other international tax forms. If applicable, the pass-through entity may be required to file Schedules K-2 and K-3.

Exceptions for Domestic Partnerships and S Corporations

Under the latest guidance, announced in early February, certain domestic partnerships and S corporations won’t be required to file the schedules if they satisfy all of the following requirements:

  • For the 2021 tax year:
    • The direct partners in the domestic partnership aren’t foreign partnerships, corporations, individuals, estates or trusts, and
    • The domestic partnership or S corporation has no foreign activity, including 1) foreign taxes paid or accrued, or 2) ownership of assets that generate, have generated or may reasonably be expected to generate foreign-source income.
  • For the 2020 tax year, the domestic partnership or S corporation didn’t provide its partners or shareholders — nor did they request — information regarding any foreign transactions.
  • The domestic partnership or S corporation has no knowledge that partners or shareholders are requesting such information for the 2021 tax year.

While entities that meet the criteria outlined above generally aren’t required to file Schedules K-2 and K-3, there are certain situations that would require the entity to file the schedules with the IRS. This could occur   if a partnership or S corporation is notified by a partner or shareholder that it needs information included on Schedule K-3 to complete its tax return. If that notification occurs before the entity files its own return, it would need to provide Schedule K-3 to the partner or shareholder and file the schedules with the IRS.

Determining if Schedules K-2 and K-3 are Needed

To help determine if Schedules K-2 and K-3 are needed, you should consider surveying the partners or shareholders for certain information to help with compliance. Because of these new rules and delays with the IRS accepting these schedules for electronically filed returns, a tax return filing extension may be needed to file a complete and accurate return.

If you are unsure about this new reporting requirement, Janover can help. Our team of experienced, knowledgeable professionals can assist you with all of your tax and financial planning needs, especially as they relate to domestic vs international pass-through entity reporting. Please contact us if you have any questions or need assistance.

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