The Internal Revenue Service has released draft versions of its
In response to feedback from stakeholders, the draft instructions, which were released last week, include a new filing exception, which is described on page 3 of the 2022 instructions for Schedules K-2 and K-3. The IRS is asking for further comments on the draft instructions, which should be emailed to
Tax professionals might well decide to weigh in, since there seem to be some problematic areas.
"The sections that created the most problems for domestic partnerships involved items related to information that might be necessary for partners related to reporting foreign tax credit items," wrote Ed Zollars, a partner at Thomas, Zollars & Lynch CPAs, on his
He noted that the exception is a modification of the special relief offered for 2021 filings in Question 15 of the "
"A partnership with no foreign source income, no assets generating foreign source income, no foreign partners, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3," said the IRS. "For example, if the partner claims a credit for foreign taxes paid or accrued by the partner, the partner may need certain information from the partnership to complete Form 1116 or 1118. Also, a partnership that has only domestic partners may still be required to complete Part IX when the partnership makes certain deductible payments to foreign related parties of its domestic partners. The information reported in Part IX will assist any domestic corporate partner in determining the amount of base erosion payments made through the partnership, and in determining if the partners are subject to the base erosion and anti-abuse tax. Further, if the domestic partnership with no foreign activity or foreign partners has direct or indirect domestic corporate partners, Part IV (concerning foreign-derived intangible income) may need to be completed. A domestic or foreign publicly traded partnership as defined in Section 7704(b) (PTP) with no foreign activity or foreign partners may need to complete Part XI."
Partnerships only recently needed to worry about filing Schedules K-2 and K-3 to report on foreign activity, and there has been confusion about the requirements. The IRS introduced the new reporting requirement for the 2021 tax year for any passthrough entities with international activities, creating the two new forms to supplement all their Schedule K-1 filings. These forms are supposed to clarify and standardize the reporting and documentation of international items to the IRS, but many organizations have been uncertain about what to do because not all parts of these forms are relevant to every exempt organization, and figuring out which parts are relevant requires extra analysis.
"When it was first introduced, many people thought this wasn't going to be that big of a burden or 'I don't really have international activity, so I'm OK,' but unfortunately, once the instructions were released for the forms, it became very clear that this was going to be a very big undertaking by many partnerships, and that there would be few exceptions," said Kristin Kranich, partner and international tax services leader at Top 25 Firm Crowe in San Francisco. "Being a partnership that is considered to not have any international relevance is a rare situation, given the global environment that we're in. As September 15 wrapped up — which was the partnership deadline for a calendar-year partnership — we saw extensive amounts of work that had to go into these forms that maybe the IRS and taxpayers underestimated. Just determining if you have items of international relevance is something that takes some time to go through the form and understand for the different sections of the form what might or might not apply to your entity and to your partners."
The guidance released on the FAQ page in February may have helped a bit. "The instructions had stated upfront that you had to attach a K-2 or a K-3 if you had any partner that was claiming a foreign tax credit or could be claiming a foreign tax credit, so that could mean you have absolutely no foreign activity, but you still had to populate this extensive form," said Kranich in an interview last month, ahead of the release of the draft instructions. "So the IRS provided a little bit of relief in February, saying that as long as you as a partnership have no foreign activity, no foreign partners, and none of your partners have asked for this information, then you can not file it just this year in 2021. They haven't clarified that will remain an exception going forward, so that helps a little bit. But oftentimes what we saw was, companies still had to file because maybe they had a tiered partnership structure, so a partnership up above needed the information to add to its information because it had foreign activity that it had to share with its partners or shareholders. It became an extensive amount of reporting for the majority of partnerships and corporations."
The available technology wasn't ready to handle the new requirements on both the IRS side and the partnership's end.
"There was definitely frustration over how extensive this reporting was, and the fact that it was released and developed early in the the filing season, but without an ability to e-file it at first, and the software wasn't ready for it, so it just added even more stress and burden to taxpayers," said Kranich. "I think many were probably frustrated with the amount of additional reporting and costs to them to comply with something that they felt maybe wasn't very material or applicable to their organization. Unfortunately, because it's a mandatory form that the IRS has put out and carries penalties with it for failure to file, they really had no choice in the matter. The IRS, with the frequently asked questions, said in the first year there would be penalty relief as long as you made a good faith effort, but that meant you still had to go through the process of gathering the information, doing the analysis and preparing the forms."
Despite the extra burden, the new forms could provide some benefits as well. "What the IRS has said all along is truly a benefit of these forms is that prior to the K -2 and K-3 being released, partnerships technically still had to provide all of this information," said Kranich. "Whether they did or didn't — or provided it to the extent that the partners truly needed it to comply with the international tax rules — is another question. But technically, partnerships would have needed to provide their partners with the same amount of information so partners could comply with all of the international tax rules, especially post-Tax Cuts and Jobs Act, when we saw the new rules around GILTI and we've continued to see changes to foreign tax credit regulations and all of that."
"This was information partners always needed and the partnerships were just providing that through footnotes to the K-1s, and everybody was providing that in a different format," she continued. "That made it difficult for taxpayers as well because you had to really dig into the footnotes to understand what might be applicable to you, and what was there because it was applicable to some other partners in the partnership, but you could ignore it because you don't meet certain thresholds or whatever the case is. What this did is standardize all of that international reporting for taxpayers. The K-1 recipients in the past had to dig through all of these pages and pages of footnotes. Now they do have standardized reporting when they receive their K-3. It's now pages and pages of the K-3 in some instances, but at least it's all in the same format."
