The 2021 tax season is upon us and, as always, the ever-evolving tax landscape presents changes that might impact your tax preparation and planning that we want to share with you.
New Filing Requirements: Schedules K-2/K-3 for Partnerships and S Corporations
The IRS (Internal Revenue Service) created new Schedules K-2 and K-3 for the 2021 tax year which may cause delays when filing your 2021 partnership and S corporation tax returns. While these forms were intended to cover foreign activities, recently released IRS instructions required their inclusion in many partnership and S corporation tax returns, even those with only domestic US activities and domestic owners.
- Partnership Instructions for Schedules K-2 and K-3 (Form 1065)
- S Corporation Instructions for Schedules K-2 and K-3 (Form 1120-S)
These new forms were released to create consistency in reporting information of foreign income tax relevance. On January 18th, the IRS clarified that these forms apply to domestic partnerships and S corporations whose direct or indirect partners/shareholders file Form 1116 or Form 1118 to claim a foreign tax credit—even if the partnership or S corporation itself has no foreign partners, foreign income, or foreign investments.
Pushback From Tax Professionals
There was a substantial uproar as it relates to the amount of work involved for so many purely domestic entities to complete these substantial schedules. The penalties for failing to file these new forms are extensive, so it is important to carefully review if these apply to your partnership or S corporation. In response to the furor, the IRS issued new guidance, again, on February 16th, which walks back the need for many domestic pass-through entities to complete these schedules for 2021.
The relief for tax year 2021—noted in the Frequently Asked Questions section, FAQ #15—is the most critical here. A new exception (using the January 18th guidance and instructions as a baseline) to filing Schedules K-2 and K-3 is as follows:
- Direct partners in the partnership or S corporation are not foreign entities
- The pass-through entity has no foreign income, deductions, or credits to allocate for 2021
- For tax year 2020, the partnership or S corporation did not provide tax information to its owners that dealt with PFICs, CFCs, etc. on Schedule K-1
- The entity is not aware that any partner or shareholder desires to have a Schedule K-3 issued to them
NOTE: The relief outlined in FAQ #15 only applies to 2021 and you must meet all four factors of the newest exception. Purely domestic entities may end up needing to complete these schedules for tax year 2022. Stay tuned.
Expectations and Timing
The forms required could include up to 12 different parts each, and the time required will vary depending on a client’s specific tax situation. Additionally, the forms are not fully functional yet—neither by the IRS nor any of the major tax software companies, including our provider, CCH (one of the largest in the US). We expect to be able to start e-filing affected returns around February 20th in some scenarios, but we may not have full functionality until late April for partnerships and summertime for S corporations, which may require us to extend returns in some situations. It is worth noting that these new forms will also create additional compliance time for you and for your SC&H Tax team.
A member of your tax team will be reaching out to discuss implications to your partnership or S corporation, if applicable.
For Individual Tax Clients
IRS online resources for the 2022 filing season are available here. You can locate data regarding 2021 estimated tax payments and advance child tax credits and recovery rebate payments at this site.