Schedule K-2 and K-3’s Impact on Auto Dealers

In the fall of 2021, the IRS announced two new tax schedules — Schedule K-2 and Scheduled K-3 — reporting items of international tax relevance.

According to the IRS, portions of the existing partner and shareholder Schedule K and K-1 have been removed and incorporated into these new, separate filings. The goal? More details about items of international tax relevance from the operation of a partnership or S corporation.

These additional details and the increased amount of information needed to compete these new schedules could cause a delay in the delivery of partner and shareholder tax packages. More importantly, the changes could lead to a significant increase in compliance costs.

Why are the new forms needed?

The new forms were created to reduce confusion on the Schedule K. In the past, Schedule K and K-1 did not require specific formatting, which caused confusion. The new forms help to reduce confusion, inconsistent reporting, and inquiries by providing reporting consistency and clarity, while enabling the IRS to “verify [that] partnership and S Corp items are properly reported on partners’ and shareholders’ returns.”

Historically, there has been a lack of consistency in various items needing reporting to partners and shareholders.

In addition to standardizing how certain items are reported, the new schedules:

• Provide detailed information about sourcing for flow-through investors and partners.
• Clarify responsibilities and standardize reporting formats.
• Supply detailed information on sourcing and foreign-derived intangible income.

How does this impact my business?

For all partnerships and S corporations, the new schedules will add a major reporting requirement, whether the entity has international operations or not.

For larger businesses, the new schedules contain comprehensive information on sourcing and other items of international relevance.

The forms may be filed electronically, however electronic filing capabilities are not yet available. If you electronically file your return before the form release dates, submit your schedules as separate PDF files attached to the return.

Form Release Dates from the IRS (current as of March 17, 2022):

Form Number                                                     Date Available

Form 1065, Schedules K-2 and K-3             March 20, 2022

Form 1120-S, Schedules K-2 and K-3          Mid-June 2022

Form 8865, Schedules K-2 and K-3               January 2023

I don’t have any foreign activities nor partners. Do I still need to file these forms?

In many instances, a partnership or S corporation with no foreign partners, foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3. For example, if the partner or shareholder claims the foreign tax credit, the partner generally needs certain information from the partnership on Schedule K-3, Parts II and III, to complete Form 1116. Read the IRS’ FAQ #11 as well as the IRS instructions and changes released in mid-January), the changes to the original instructions for more details on why and when you might need to complete these schedules.

What if I submit incorrect forms?

The IRS claims that, “Taxpayers who make a good faith effort to comply with the new schedules for tax year 2021 will not be assessed a penalty. A filer will not be subject to penalties if it made a good faith effort to determine whether it must file a part and how to complete a part if it determines it must file.”

As with many tax areas, this is no different and carries with it significant complexity. Work with our tax professionals to help you sort through the confusion.

Unless the above content expressly provides that the statements contained therein are intended to constitute written tax advice within the meaning of IRS Circular 230 10.37, this message is intended to communicate general information for discussion purposes only, and you should not, therefore, interpret the statements to be written tax advice or rely on the statements for any purpose. We will conclude that you have understood and acknowledged this important cautionary notice unless you communicate to us any questions you may have.