International tax information reporting for 2021 brings the addition of two new schedules for passthrough entity tax returns: Schedules K-2 and K-3. Filing requirements may impact domestic partnerships and S corporations with no apparent items of international tax relevance, however, the IRS has provided filing relief for tax years beginning in 2021.

Background

For years, international tax information was reported on Schedule K as part of the entity return, and provided to shareholders and partners within Schedule K-1 and its footnotes. But for tax years beginning in 2021 and thereafter, this reporting will be moved to and expanded upon in new Schedules K-2 and K-3.

The IRS is hopeful that these form changes will help standardize previously inconsistent reporting so that passthrough owners may properly complete filings with respect to international tax items.

Impacted passthrough entities will now complete:

• Schedule K;

• Schedule K-1;

• Schedule K-2; and

• Schedule K-3.

Partners and shareholders will generally now receive:

• Schedule K-1; and

• Schedule K-3.

Impact on Domestic Entities

On the surface, it may appear these schedules would be necessary only for businesses with items of international tax relevance at the entity level. However, the IRS has clarified in its instructions and communications that domestic partnerships and S corporations with no foreign owners or international activity of their own may still be required to file certain parts of the new schedules.

For example, purely domestic passthrough entities with no international activity may be required to complete the foreign tax credit sections of Schedules K-2 and K-3 for partners and shareholders claiming a foreign tax credit on their personal tax returns related to activities outside of their businesses.

As another example, a passthrough entity with a corporate partner is required to complete part IX with respect to Base Erosion and Anti-Abuse Tax (BEAT) information to determine BEAT applicability of the corporate partner itself.

2021 Filing and Penalty Relief

Penalties may apply for filing Form 1120-S or Form 1065 without Schedules K-2 and K-3 where required. Late filing penalties of $210 per month, per partner or shareholder, in addition to a $280 penalty per partner or shareholder for failure to furnish information may apply if the schedules are not properly completed. If the reporting requirement is intentionally disregarded, an increased penalty may apply.

Filing Exemption for Certain Domestic Passthroughs for 2021

Because the reporting changes may pose challenges, the IRS is providing a filing exception for certain domestic passthrough entities for tax years beginning in 2021 within the Schedules K2 and K3 Frequently Asked Questions.

FAQ #15 explains the conditions that must be met to qualify for the 2021 filing exception:

1. In tax year 2021, the direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts. 
2. 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 expected to generate foreign source income (see section 1.861-9(g)(3)).
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 regarding (on the form or attachments thereto):
   • 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 (line 17d for Form 1120-S).
4. The domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting such information for tax year 2021.

As noted in IRS FAQ #15, if the schedules are requested after the return filing, pro forma Schedule K-3 should be provided, but not required to be submitted to the IRS. If the schedules are requested before the return filing, the schedules must be included and submitted to the IRS and owners (the exception has not been met).

Penalty Relief for 2021

Separately, the IRS previously provided penalty relief in Notice 2021-39. For 2021 only, relief from incorrect or incomplete filing penalties is available if a good faith effort to comply with new reporting requirements is made. For a good faith attempt, the IRS will take into account items including:

• Changes to systems, processes, and procedures for collecting and processing information related to filing Schedules K-2 and K-3;
• The extent to which a filer has obtained information from partners or shareholders, or applied reasonable assumptions when information is not obtained; and
• Steps the filer took to modify the partnership or S corporation agreement or governing instrument to facilitate the sharing of information with partners and shareholders relevant to the K-2/K-3 filing determination.

Under the Notice, a Schedule K-2/K-3 filer is initially required to make a good faith effort to comply with the new reporting requirements, however, for certain domestic passthrough entities these requirements are relaxed with the issuance of IRS FAQ #15.

Communication Is Key

To avoid unnecessary penalties, passthrough entities should be aware of the new reporting requirements and have ongoing communication with their owners and tax advisors as to which parts of Schedules K-2 and K-3 may be required.

Please contact one of RubinBrown's tax professionals with questions, concerns or to learn more. 

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