Recently, the IRS has released updated instructions related to two new schedules that may be required to be filed for the tax returns of pass-through entities for tax years beginning in 2021. Initially, partnerships and S-corporations were expected to file the new Schedules K-2 and K-3 related to any relevant foreign tax items resulting from the entity’s activity, including foreign investments or operations and transactions with foreign owners.
Within the updated instructions, released on January 18, 2022, the IRS has stated additional reasons for an entity to file these schedules. Even if the entity doesn’t have any foreign tax exposure, the instructions now specifically include filing of the forms when an owner of the entity must file Form 1116 to receive a foreign tax credit on their individual return. This new requirement will affect a large number of returns that were not originally included in the filing requirements when the schedules were drafted last summer. It will also add time to determine each owner’s individual tax situation, prior to the filing of the tax return for the entity.
The new reporting requirement can include an additional 20 pages for each Schedule K-2 and each K-3 that are required to be filed. Due to the new reporting, taxpayers should be prepared for additional preparation time and potential extensions of their return, as the schedules are not currently available to be electronically filed. In a letter to Janet Yellen and IRS Commissioner Rettig dated February 10, 2022, a group of senators requested relief for taxpayers including modifying the current implementation of these schedules.