US LLCs with Foreign Partners Have New Reporting Requirements: K2 and K3 IRS Forms
The IRS released new draft schedules K-2 and K-3 for the tax year 2021 Form 1065, US return of Partnership Income.
The new schedules and instructions will help partnerships report certain US international tax information to their partners in a standard format. The IRS hopes this information will help partners compute and report their corresponding US tax liability, including the new international tax regimes under the Tax Cuts and Jobs Act of 2017.
The new IRS schedules and instructions include:
- Schedule K-2 (Form1065), Partners’ Distributive Share Items – International.
- Schedule K-3 (Form 1065), Partner’s Share of Income, Deductions, Credits, etc. ¾ International.
- Partnership Instructions for Schedule K-2 (Form 1065) and Schedule K-3 (Form 1065).
- Partner’s Instructions for Schedule K-3 (Form 1065).
Revisions to the 2021 IRS Forms 1120-S, US Income Tax Return for an S Corporation, and 8865, Return of US Persons With Respect to Certain Foreign Partnerships, are expected soon. The IRS invited comments on the changes.
Partnerships & Timelines
Partnerships without US international tax items remain unaffected by the new draft schedules. However, partnerships that will have to complete the new schedules for the tax year 2021, filing season 2022 are those that:
- Must file a US partnership tax return.
- Have items of US international tax relevance.
Affected stakeholders could review the proposed changes and submit comments which the IRS considered until September 14, 2020. The IRS planned to finalize the forms in late 2020.
The current situation:
Partnerships, private equity funds, and alternative asset management funds report their international tax information over various forms and schedules. They pass much information to the partners using:
- Supplemental Statements.
- Whitepaper disclosures.
- Pro-forma forms.
- Footnotes attached to Schedule K-1.
The current regime lacks a standardized format. As a result, partners that receive the same sometimes find it hard to translate the information for different partnership investments to the required tax returns. The new schedule offers a standard format for filing US international tax information to partners. These include withholding and sourcing details for foreign partners and US international inclusions or foreign attributes relevant for domestic partners.
The new situation:
The new forms will streamline tax reporting and filing AND make it easier for the IRS to verify the returns. The information required is most likely already available, and partnerships already provide it to their partners. \
- In addition, the new schedules will replace some of the reporting currently reported on Schedule K-1 (IRS Form 1065).
- Schedule K-2 replaces parts of Schedule K, lines 16(a) to 16(r)
- Schedule K-3 replaces parts of Schedule K-1, Part II, Boxes 16 and 20.
Schedule K-3 is similar to Schedule K-1 = it is to be completed for each partner and reflects their allocable share of the international tax items reported by the partnership in Schedule K-2.
The information included in the draft schedules
Draft Schedules K-2 and K-3 include reports of the following items. Every item has consistent parts on each of the schedules.
- PART I: Partnership’s share of current tax year international transactions.
- PART II: Foreign Tax Credit Limitations.
- PART III: Other information for preparation of Form 1116 or 1118.
- PART IV: Other foreign transaction information for US partners, amongst others:
- Information on partner’s IRC Section 250 deduction for foreign-derived intangible income (FDII)
- Distributions from foreign corporations to partnerships.
- PART V: Controlled Foreign Corporation (CFC) and Global Intangible Low-Taxed.
Income (GILTI) inclusions
- PART VI: PFIC and QEF Information.
- PART VII: Partner’s Share of partnership’s interest in foreign corporation income (IRC Section 960).
- PART VIII: Base Erosion and Anti-Abuse Tax (BEAT) IRC Section 59A information.
- PART IX: Non-US, foreign partners’ character and source of income and deductions of the partnership.
- The new schedules present additional reporting complexities for private equity and alternative asset management funds with international activities.
- The added detail may create an increased tax compliance burden for funds
- The added detail may make new investor-relation issues and timing issues more complicated because of the requirement to deliver Schedule K-1s and Schedules K-2 and K-3.
Funds should revise the timeline and deadlines for providing tax packages that include these schedules. Alternatively, funds can allocate the additional costs for preparation to the partners to whom the partnership has to provide the new schedules. These new issues and expenses should be addressed when new partnership agreements or side letters are signed or existing ones revised.
PLEASE NOTE: The draft schedules do not replace current US international tax information reporting requirements for partnerships. For example, IRS Forms 5471, 926, 8621, and others are still required. Partnerships, private equity, and alternative asset management funds must provide the information included on these schedules to their partners. They would use the information to satisfy their existing tax obligations.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intends for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
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