The IRS plans new versions of its schedules K-2 and K-3 for partnerships. The new versions put relatively few limits on the need to report information, though there is a new filing exception. Affected clients should still file these schedules carefully.

“With the updated instructions, more clients will be required to file the forms this year,” said Lesley Keller, director, tax services at Sikich. “The exceptions in the prior year made the exemption to file much easier.”

Kim Racer-Robinson, a senior tax manager in the Philadelphia office of Armanino LLP, said that four criteria to qualify for the Domestic Filing Exception are: the partnership had no or limited foreign activity; all partners are U.S. persons; all partners are notified within two months prior to the due date of the return without extension that they will not receive a Schedule K-3; and the partnership does not receive any requests for a 2022 Schedule K-3 by the “1-month date.”

“If the partnership has no foreign source income or assets, no foreign taxes paid or accrued and all partners are U.S. citizens or resident alien partners … the partnership must notify all the partners that the partnership will not provide Schedule K-3 to the partners,” Keller added.

Timing is key in all matters of the filing. This notification is required Jan. 15, for instance, two months prior to the due date of the partnership return, Keller said.

“The partners have 30 days, until Feb. 15, to respond if they require the form,” she added. “If requested by a partner, the partnership must file the K-2/K-3s. If a request is made by a partner after the 30 days, the partnership is only required to provide the K-3 to the requesting partner. It’s not required to file the K-2/K-3s with the return submitted to the IRS.

“The other requirement would be if any of the partners in the partnership are corporations, partnerships or S-corporations,” Keller said. “The Form 1116 exemption exception follows the same notification process as above.”

Partnerships should consider a process to document the tracking and determination that the Schedule K-2 and K-3 isn’t required to ensure there are no penalties associated with filing an incomplete return, Racer-Robinson added.

International connections aren’t the only tripwires for filing. A partnership that has only domestic partners may still be required to complete part of the schedules when the partnership makes certain deductible payments to foreign related parties of domestic partners. If the domestic partnership with no foreign activity or foreign partners has direct or indirect domestic corporate partners, another part may need to be completed.

There are also other reasons to file a K-2 or K-3. “Partners that claim a credit for foreign taxes paid on their individual return via Form 1116 may still need information from the partnership to properly complete their tax returns,” Racer-Robinson said. “Even though a partnership may not have any foreign activity, it may still want to prepare Schedules K-2 and K-3.

“Due to the various nuances and process needed to track, document and communicate to partners about the change, many partnerships may decide to complete Schedules K-2 and K-3 for 2022 to provide consistent treatment with what had been done for 2021 and to provide all information to their partners,” Racer-Robinson said. “Some of the FAQs and other clarifications provided by the IRS should hopefully make the process more streamlined.”

Some have expressed frustratration with the additional reporting and the expenses to comply – especially considering that the reporting was for details considered material or non-applicable to many organizations. The form being mandatory from the IRS – with failure-to-file penalties – leave partnerships with little choice.

“Communicating the new notification process to clients is most important,” Keller said. “If a client fails to meet the notification deadline, they’re required to file the schedules even without foreign activity. Determining if the client meets the exception by Jan. 15 may also prove difficult if they’re unable to obtain good financial information for [this] year end.”

There’s potential for further updates to these schedules’ instructions, Keller said.