New K-2 and K-3 Relief for Pass-Through Entities

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On February 16, 2022, the IRS announced new relief measures for qualifying pass-through entity (PTE) businesses. The relief measures are related to K-2 and K-3 schedules, which are elements of international tax reporting.

Here’s what you need to know about K-2 and K-3 schedules, pass-through entities, and if your business qualifies for this exemption.

What kinds of businesses qualify? 

Pass-through entities (PTEs), also known as “flow-through entities,” could qualify for the new exemption. These are legal business entities where all income is passed on to the owners or investors of the business. Partnerships and S corporations (companies that pass on all income to shareholders) are included within pass-through entities.

What are K-2 and K-3 Schedules? 

K-2 and K-3 schedules have to do with a partner or a shareholder’s share of items with international tax relevance. At the beginning of FY21, these schedules replaced parts of Schedule K.

These additional schedules were created to help companies increase information transparency and reduce uncertainty about how and what to report for international taxes.

How does this affect my business? 

This new exemption allows businesses to skip these additional schedules as long as they meet the IRS exemption requirements.

If your business is a pass-through entity but doesn’t meet these requirements, then you are still required to include K-2 and K-3 schedules when filling out your FY2021 income tax returns.

Additionally, your company is considered ineligible if a partner or shareholder requests the information for their tax return, even if your business is deemed eligible.

How do I know if my business qualifies for the exemption?  

According to the IRS’s latest notice, domestic partnerships and corporations must meet the following conditions to be eligible to omit schedules K-2 and K-3 when filing: 

• FY2021, Direct partners in a domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts. 

• FY2021, 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 expect to generate foreign source income. 

• FY2020, the domestic partnership or S corporation did not provide to its partners or shareholders (nor did they request) information regarding: 

  • Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S) 

  • Line 20c, Form 1065, Schedules K and K-1 (Controlled Foreign Corporations, Passive Foreign Investment Companies, 1120-F, section 250, section 864(c)(8), section 721(c) partnerships, and section 7874); line 17d for Form 1120-S. 

• The domestic partner or S corporation has no knowledge that the partners or shareholders are requesting such information for the FY2021 tax year.   

Questions 

Have questions about how this change affects your businesses specifically? Our team of business tax experts is here to help. Contact us today to get started with one of our tax experts.