IRS issues draft instructions for Partnership Schedules K-2 and K-3 for 2022 tax returns.
On October 25, 2022, the IRS issued a draft set of instructions for partnership’s 2022 Schedule K-2 and K-3. An important element is the “Who Must File” section, because some partnerships might not have to file these two international schedules, but pay attention to the four criteria and the respective dates to meet these criteria.
The draft instructions can be found here: https://www.irs.gov/pub/irs-dft/i1065s23–dft.pdf
The Schedules K-2 and K-3 first come into existence for the 2021 tax returns that were filed in 2022. These draft instructions cover the 2022 tax year and the related returns will be filed in 2023. These schedules are related to international business activities by a US partnership. The complaint about these new forms has been that they are complicated (very complicated) and businesses that have no foreign activity and no foreign owners shouldn’t have to file them. So, let’s focus on the draft language of who must file these forms.
Who Must File 2022 Schedules K-2 and K-3
The instructions for who must file the international Schedules K-2 and K-3 start on page 2 of the instructions. The first thing to understand is that the IRS assumes that all partnerships will need to file these forms, unless the partnership falls into an exception. The instructions address “Domestic filing exception (exception to filing Schedules K-2 and K-3)” by saying that a domestic partnership doesn’t need to complete and file the schedules, or furnish the schedules to a partner if they meet the following four criteria with respect to the partnership’s tax year 2022. Note that if a partner requests one of these schedules, the partnership must provide it. So, let’s take a look at the criteria.
Criteria 1 – No or limited foreign activity
The first criteria is that the domestic partnership does not have foreign activity, or if it does have foreign activity it is very limited. The instructions give very specific criteria for what the IRS considers to be foreign activity, and how much is considered limited activity.
Criteria 2 – U.S. Citizen/resident alien partners
During the 2022 tax year, all direct partners are (a) U.S. citizens, (b) resident aliens, (c) domestic decedent’s estate, (d) domestic grantor trust, or (e) domestic non-grantor trust. There are lots of specific items if there is any owner with a potential non-US citizen designation. If there’s anything remotely foreign in the ownership structure, look closely at the definitions provided by the IRS.
Criteria 3 – Partner notification
This criteria is going to be the biggest pain, but it appears you must meet this criteria to avoid having to prepare and file Schedules K-2 and K-3 for 2022. Remember, the partnership must have already satisfied the first two criteria that establishes they have no foreign activity and no foreign (or very limited) foreign business income or activity, then they have to go through this notification process.
The notification must be sent to all partners either electronically or by mail dated no later than 2 months before the due date (without extension) for filing the partnership’s 2022 Form 1065. The notification must state the partners will not receive Schedule K-3 from the partnership unless the partners request the schedule.
Criteria 4 – No 2022 Schedule K-3 requests by the 1-month date
This criteria is that the partnership doesn’t receive a request from any partner for Schedule K-3 on or before one-month before the due ate (without extension) of the partnership’s Form 1065. For tax year 2022 calendar year partnerships, this 1-month date is February 15, 2023.
Summary of the dates to watch for:
To meet Criteria 3, you must send out a notice by January 15, 2023 telling the partners that they will not receive a Schedule K-3.
To meet Criteria 4, you must not have received a request for Schedule K-3 from a partner by February 15, 2023.
If you notify the partners by January 15, 2023 that they won’t receive the Schedule K-3 and no partner responds by requesting Schedule K-3 by February 15, 2023, then the partnership doesn’t need to prepare and file complete Schedules K-2 and K-3 for 2022 tax year for all partners. HOWEVER, keep reading the instructions because, if a partner fails to request the Schedule K-3 by February 15, 2023, any partner can still request it after that date and the partnership will have to provide the requested information for that partner.
One of my initial take-aways is that if the partnership misses the January 15, 2023 date to notify the partners, they would be required to prepare and file the 2022 Schedules K-2 and K-3.
I know these instructions are in draft format and they could change, but at least we know where the IRS might be heading in terms of requiring domestic partnerships to file these schedules if they partnership doesn’t have foreign owners or foreign activity.