Has Your Partnership or S Corporation Met the August 15 Notice Requirement to Avoid Filing 2022 Schedules K-2 and K-3?

Starting with 2021 Forms 1065 and 1120S, partnerships and S corporations have been burdened with complex Schedules K-2 and K-3 reporting requirements related to partners’ and shareholders’ shares of international items, even when the entity has little or no foreign activity. The Internal Revenue Service (IRS) unveiled several versions of draft guidelines for the 2022 Schedules K-2 and K-3 for partnerships and S corporations. These instructions introduce a novel domestic filing exception, which aims to ease the filing process for certain partnerships and S corporations that meet specific requirements, exempting them from the necessity to file Schedules K-2 and K-3 with their 2022 tax returns. Eligibility for the exception depends on several conditions, including one with an August 15, 2023, notice requirement for partners and shareholders.

What Is the New Exception?

In the new exception, a domestic partnership or S corporation (filing entity) is exempted from filing Schedules K-2 and K-3 with IRS or providing Schedule K-3 to its partners or shareholders (unless specifically requested), provided all of the following four conditions are fulfilled for the tax year:

1. The filing entity has no foreign activities or only has passive income foreign activities generating no more than $300 in eligible foreign tax credit.
2. In the 2022 tax year, all direct owners of the filing entity are either U.S. residents or citizens, domestic decedent’s estates or trusts with solely U.S. beneficiaries, S corporations with a sole shareholder, or single-member LLCs disregarded due to the sole member being one of the above-listed persons.
3. The filing entity’s owners have been notified by the partnership or S corporation that they won’t receive Schedule K-3 unless requested. This notification must be provided when the entity provides Schedule K-1 to the owners.
4. No partner or shareholder requests the Schedule K-3 information one month before the entity files its 2022 tax return (the one-month date). The final one-month date for 2022 tax year partnerships and S corporations is August 15, 2023, assuming the entity timely filed an extension.

If an owner that received notification that no Schedule K-3 will be issued requests Schedule K-3 at least one month prior to the date the entity files its 2022 return, the filing entity is obligated to prepare both Schedule K-2 and Schedule K-3 relevant to that owner and submit these schedules to the IRS. However, if an owner requests Schedule K-3 after the one-month period has passed, the filing entity satisfies the criteria for the domestic filing exception, and it is not required to file Schedule K-2 and K-3 with the IRS.

Regardless, the filing entity must still supply the requesting owner with their Schedule K-3, either when the entity files its 2022 return or one month after the owner’s request for Schedule K-3, whichever comes later.

How Does This Change Affect My Partnership or S Corporation?

Given these provisions, partnerships and S corporations are encouraged to assess the applicability of the domestic filing exception to their circumstances, keeping in mind the varied criteria and potential requests from owners. For entities with eligible profiles, this exception can help to simplify tax filing procedures, reducing the burden of completing and filing Schedules K-2 and K-3.

However, partnerships and S corporations need to carefully navigate the communication with their owners, as they are required to provide Schedule K-3 to any owner who requests it after the one-month date. The timely handling of such requests is crucial, as failing to meet the deadlines could lead to compliance issues. Partnerships must also remember to comply with the requirements for the following tax year if an owner has made a request.

To fully utilize this exception, filing entities must meticulously evaluate each criterion and maintain the necessary documentation, with particular attention paid to the one-month date, as partnerships and S corporations must carefully track partner or shareholder requests for Schedule K-3 and their correlation with the anticipated filing date. Even if a request comes after the one-month date and the filing entity meets the other three criteria, it still needs to provide a Schedule K-3 to the owner who made the request.

Understanding the nuances of the domestic filing exception and its implications for partnerships and S corporations submitting Schedules K-2 and K-3 is essential, as the correct application and impact on owners must be thoroughly grasped to avoid potential tax-related discrepancies. Should you have any questions concerning the domestic filing exception, contact your CRI advisor. They are well-equipped to provide the insights and guidance needed to navigate these complexities successfully.