International tax reporting on proposed partnership Schedules K-2 and K-3

| 11/19/2020
International tax reporting on proposed partnership Schedules K-2 and K-3

On July 14, 2020, the IRS released two new schedules proposed to be added to the 2021 Form 1065, “U.S. Return of Partnership Income”: Schedule K-2, “Partners’ Distributive Share Items – International,” and Schedule K-3, “Partner’s Share of Income, Deduction, Credits, etc. – International.” These forms provide the IRS and partners with standardized information about partnership items of international tax relevance.

Background

The Tax Cuts and Jobs Act of 2017 added numerous international tax provisions that affect the taxation of partnerships and their partners. The current schedules associated with the Form 1065 do not provide partners with sufficient information to comply with their U.S. filing requirements. Instead, partnerships report this information within footnotes attached to the partners’ K-1 package. As a result, partners receive varying levels of detail about international tax-related items from each investment or need to follow up with the partnership to obtain all the information required to comply with the new international tax provisions on their own returns.

This lack of standardized international tax information from partnerships also means that the IRS is unable to capture this information electronically and use it in its compliance and enforcement activities.

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New international tax reporting schedules

Draft forms were released that would make partnership international tax-related reporting more transparent and consistent. They also would increase the likelihood that partners receive necessary information at the appropriate level of detail in a consistent format from all investments. This standardization should help partners more easily and accurately compute their U.S. income tax liability with respect to international tax attributes that flow through partnerships and provide the IRS with more accurate information about these items.

Generally, a partnership would be required to file the new Schedules K-2 and K-3 if it has items of international tax relevance from the operation of the partnership, including items that affect the determination of U.S. tax or that are needed for partners to comply with U.S. withholding or reporting obligations. A partnership would be required to complete only the relevant parts of Schedules K-2 and K-3. For example, partnerships not computing foreign taxes would not be required to complete Parts II, III, or VII of Schedules K-2 and K-3. Additionally, if the partnership does not have any items of international tax relevance, the schedules would not be required.

Schedule K-2 has nine parts, and Schedule K-3 has 10 parts. These separate parts, used to report the most common international tax provisions, are as follows:

  • Part I: Relates to current year international transaction information including gain on personal property sale, foreign oil and gas taxes, splitter arrangements, foreign tax translation, high-taxed income, and Section 267A disallowed deduction
  • Part II: Relates to the foreign tax credit limitation
  • Part III: Includes other information for preparation of Form 1116 or 1118
  • Part IV: Provides other foreign transaction information for U.S. partners including foreign-derived intangible income, Section 743(b) adjustments, and distributions from foreign corporations
  • Part V: Includes information regarding Subpart F and global intangible low-taxed income inclusions
  • Part VI: Provides information regarding passive foreign investment companies
  • Part VII: Relates to foreign corporations income (Section 960)
  • Part VIII: Provides information related to base erosion and anti-abuse tax (Section 59A)
  • Part IX: Provides information for foreign partners’ character and source of income and deductions
  • Part X (Schedule K-3 only): Relates to foreign partners’ distributive share of deemed sale items on transfer of partnership interest

While Schedules K-2 and K-3 address the most common international tax provisions, not all international tax provisions are specifically identified on them. If a provision is not specifically identified, a footnote still will be required to be attached to both Schedules K-2 and K-3.

The Schedule K-2 is filed with the Form 1065, and the Schedule K-3 is furnished to the partners when the Form 1065 is filed. Penalties may apply for failing to timely file correct Schedule K-2s or for failing to timely furnish correct Schedule K-3s to partners.

Looking ahead

The IRS released the draft schedules more than a year in advance. Given the additional complexity and administrative burden of the schedules, the IRS might receive substantial comments to consider before finalizing the forms for 2021. The IRS plans to add similar schedules to Form 1120-S, “U.S. Income Tax Return for an S Corporation,” and Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships.”

Although Schedule K-2 and Schedule K-3 are not expected to be mandatory until tax year 2021 for use beginning in the 2022 filing season, the information required by these schedules is already necessary for partners to determine the appropriate international tax filing requirements and the associated taxation related to those items. As such, partnerships can use the forms to analyze their K-1 reporting process and make sure they are providing the appropriate level of detail so their partners can satisfy their 2020 filing and tax requirements with respect to international tax-related items.

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