Draft Instructions for Partnership Schedules K-2 and K-3

Cross References

Form 1065 draft instructions Schedule K-2 and K-3 On October 25, 2022, the IRS released draft versions of the instructions for Schedules K-2 and K-3 for partnership tax returns. The IRS revised these instructions again on December 2, 2022. Schedules K-2 and K-3 are generally used to report items of international tax relevance from the operation of a partnership. Previous draft versions of the instructions implied that all partnerships would be required to file Schedules K-2 and K-3, even if the partnership had no international tax issues to report. The new revised draft instructions have been updated to provide a filing exception for certain domestic partnerships. The revised draft instructions as of December 2, 2022 read as follows.

Domestic filing exception (exception to filing Schedules K-2 and K-3). A domestic partnership does not need to (a) complete and file with the IRS the Schedules K-2 and K-3, or (b) furnish to a partner the Schedule K-3 [except where requested by a partner after the 1-month date (defined in criteria number 4, below)] if each of the following four criteria are met with respect to the partnership’s tax year 2022.

1) No or limited foreign activity. During a domestic partnership’s tax year 2022, the domestic partnership either has no foreign activity (as defined below), or, if it does have foreign activity, such foreign activity is limited to: a) Passive category foreign income (determined without regard to the high-taxed income exception under IRC section 904(d)(2)(B)(iii)), b) Upon which not more than $300 of foreign income taxes allowable as a credit under IRC section 901 are treated as paid or accrued by the partnership, and c) Such income and taxes are shown on a payee statement that is furnished or treated as furnished to the partnership.

Foreign activity. For purposes of the domestic filing exception, foreign activity means any of the following: a) Foreign income taxes paid or accrued, b) Foreign source income or loss (as determined in IRC sections 861 through 865, and section 904(h), and the regulations thereunder), c) Ownership interest in a foreign partnership, d) Ownership interest in a foreign corporation, e) Ownership of a foreign branch, f) Ownership interest in a foreign entity that is treated as disregarded as an entity separate from its owner.

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2) U.S. citizen/resident alien partners. During tax year 2022, all the direct partners in the domestic partnership are: a) Individuals that are U.S. citizens, b) Individuals that are resident aliens, c) Domestic decedent’s estates (that is, decedent’s estates that are not foreign estates with solely U.S. citizen and/or resident alien individual beneficiaries, d) Domestic grantor trusts (that is, grantor trusts that are not foreign trusts and that have solely U.S. citizen and/or resident alien individual grantors and solely U.S. citizen and/or resident alien individual beneficiaries, e) Domestic non-grantor trusts (that is, trusts subject to tax IRC under section 641 that are not foreign trusts with solely U.S. citizen and/or resident alien individual beneficiaries, f) S corporations with a sole shareholder, or g) Single-member LLCs, where the LLC’s sole member is one of the persons in subparagraphs (a) through (f), and the LLC is disregarded as an entity separate from its owner.

3) Partner notification. With respect to a partnership that satisfies criteria 1 and 2, partners receive a notification from the partnership at the latest when the partnership furnishes the Schedule K-1 to the partner. The notice can be provided as an attachment to the Schedule K-1. The notification must state that partners will not receive Schedule K-3 from the partnership unless the partners request the schedule.

4) No 2022 Schedule K-3 requests by the 1-month date. The partnership does not receive a request from any partner for Schedule K-3 information on or before the 1-month date. The “1-month date” is 1 month before the date the partnership files the Form 1065. For tax year 2022 calendar year partnerships, the latest 1-month date is August 15, 2023, if the partnership files an extension.

Note: If a partnership receives a request from a partner for the Schedule K-3 information after the 1-month date and has not received a request from any other partner for Schedule K-3 information on or before the 1-month date, the domestic filing exception is met and the partnership is not required to file the tax year 2022 Schedules K-2 and K-3 with the IRS or furnish the tax year 2022 Schedule K-3 to the non-requesting partners. However, the partnership is required to provide tax year 2022 the Schedule K-3, completed with the requested information, to the requesting partner on the later of the date on which the partnership files the Form 1065 or 1 month from the date on which the partnership receives the request from the partner. The partnership must complete and file tax year 2023 Schedules K-2 and K-3 with respect to the requesting partner by the tax year 2023 Form 1065 filing deadline.

Note for partnerships that satisfy criteria 1 through 3, but do not satisfy criterion 4. If the partnership received a request from a partner for Schedule K-3 information on or before the 1-month date and therefore the partnership does not satisfy criterion 4, the partnership is required to file the Schedules K-2 and K-3 with the IRS and furnish the Schedule K-3 to the requesting partner. The Schedules K-2 and K-3 are required to be

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completed only with respect to the parts and sections relevant to the requesting partner. For example, if a partner requests the information reported on Part III, Section 2 (Interest Expense Apportionment Factors), the partnership is required to complete and file Schedule K-2, Part III, Section 2 with respect to the partnership’s total assets and Schedule K-3, Part III, Section 2 with respect to the requesting partner’s distributive share of the assets. On the date that the partnership files Schedules K-2 and K-3 with the IRS, the partnership must provide a copy of the filed Schedule K-3 to the requesting partner. The partnership does not need to complete, attach, file, or furnish any other parts or sections of the Schedules K-2 and K-3 to the IRS, the requesting partner, or any other partner. The partnership should keep records of the information requested by the partner.

If a partnership receives requests from partners for Schedule K-3 information both on or before the 1-month date and after the 1-month date, the partnership is required to file Schedules K-2 and K-3 as described in the prior paragraph only with respect to the partner requests received on or before the 1-month date. With respect to requests received after the 1-month date, the partnership is required to provide the Schedule K-3, completed with that partner’s requested information, on the later of the date on which partnership files the Form 1065 or 1 month from the date on which the partnership receives the request from the partner.