Section 3 of Part X on Schedules K-2 and K-3 (Form 1065) pertains to the reporting of information necessary for partners to allocate and apportion their interest expenses for foreign tax credit limitation purposes. Here’s a detailed explanation of the reporting requirements for Lines 2b, 3a, and 3b:
Line 2b: Directly Allocated Partnership Indebtedness
- Purpose: This line is used to report the average value of the partnership's directly allocated indebtedness.
- Instructions: On Schedule K-2, report the partnership’s average of the beginning-of-year and end-of-year inside bases adjustments under sections 734(b) and 743(b). On Schedule K-3, report the partner’s distributive share of the adjustments reported on Schedule K-2.
- Details: This includes any adjustments to the basis of partnership property resulting from the sale or exchange of a partnership interest or the distribution of property to a partner. These adjustments are necessary to ensure that the partner's share of the partnership's basis in its assets is accurately reflected.
Line 3a: Average U.S.-Booked Liabilities of the Partnership
- Purpose: This line is used to report the average value of the partnership's U.S.-booked liabilities.
- Instructions: These amounts may be reported by the foreign partner on Schedule P (Form 1120-F), Part III, line 11; and Schedule I (Form 1120-F), line 8, column (b). As indicated in the instructions for Part X, Section 2, line 7, the interest expense on U.S.-booked liabilities as defined in Regulations section 1.882-5(d)(2)(vii) should generally be reported by the foreign partner on Schedule P (Form 1120-F), line 8; and Schedule I (Form 1120-F), line 9, column (b).
- Details: This includes the average value of liabilities that are booked in the United States and are directly related to the partnership's U.S. trade or business. These liabilities are used to determine the interest expense that is allocable to U.S. source income.
Line 3b: Directly Allocated Partnership Indebtedness
- Purpose: This line is used to report the average value of the partnership's directly allocated indebtedness.
- Instructions: These amounts may be reported by the foreign partner on Schedule P (Form 1120-F), Part III, line 10a. The interest expense on indebtedness described in Regulations section 1.882-5(a)(1)(ii)(B) should generally be reported by the foreign partner on Schedule P (Form 1120-F), Part II, line 7; and Schedule I (Form 1120-F), line 22.
- Details: This includes the average value of liabilities that are directly allocated to specific partnership assets. These liabilities are used to determine the interest expense that is allocable to the income generated by those specific assets.
Summary
- Line 2b: Report the average value of the partnership's directly allocated indebtedness, including adjustments under sections 734(b) and 743(b).
- Line 3a: Report the average value of the partnership's U.S.-booked liabilities, which are directly related to the partnership's U.S. trade or business.
- Line 3b: Report the average value of the partnership's directly allocated indebtedness, which is directly allocated to specific partnership assets.
These lines are crucial for partners to accurately allocate and apportion their interest expenses for foreign tax credit limitation purposes, ensuring compliance with the relevant tax regulations.
Sources:
Publication 541 (3/2021)
Partnership Instructions for Schedules K-2 and K-3 (Form 1065) (2023)
Instructions for Schedules K-2 and K-3 (Form 8865) (2023)
Partner’s Instructions for Schedule K-3 (Form 1065) (2023)
S Corporation Instructions for Schedules K-2 and K-3 (Form 1120-S) (2023)
Partner's Instructions for Schedule K-1 (Form 1065-B) (2017)
Instructions for Form 1065 (2023)
