What are the Schedules K-2 and K-3

Schedules K-2 and K-3 are forms used by partnerships, S corporations, and U.S. persons with respect to certain foreign partnerships to report items of international tax relevance. These schedules were introduced for taxable years beginning in 2021 as part of an effort to provide greater clarity, consistency, and compliance in the reporting of international transactions and tax obligations. They are designed to replace, supplement, and clarify the reporting of certain amounts that were previously reported in a less structured manner on other forms and schedules.

• Schedule K-2 is an extension of the respective Schedule K for Forms 1065 (U.S. Return of Partnership Income), 1120-S (U.S. Income Tax Return for an S Corporation), and 8865 (Return of U.S. Persons With Respect to Certain Foreign Partnerships). It is used to report items of international tax relevance from the operation of a partnership or an S corporation. This includes, but is not limited to, foreign transactions, foreign taxes paid or accrued, and other items relevant to the determination of U.S. tax under the international provisions of the Internal Revenue Code.
• Schedule K-3 is an extension of the respective Schedule K-1 for Forms 1065, 1120-S, and 8865. It is generally used to report a partner's or shareholder's share of the items reported on Schedule K-2. This schedule provides the partner or shareholder with the information necessary to complete their own tax returns, particularly with respect to international tax provisions.

The introduction of Schedules K-2 and K-3 was motivated by the need for a more standardized format for reporting international tax information. Prior to these schedules, partnerships and S corporations provided international tax information in a variety of formats, which could lead to confusion and inconsistency in reporting. The new schedules aim to reduce this confusion and make it easier for partners, shareholders, and the IRS to understand and verify the reported information.

For the taxable year 2021, the IRS provided transition relief for entities required to file these schedules, indicating that penalties for incorrect or incomplete reporting would not be applied if the filer made a good faith effort to comply with the new requirements. This relief was intended to ease the transition to the new reporting requirements.

In summary, Schedules K-2 and K-3 serve as critical tools for reporting international tax information by partnerships, S corporations, and certain U.S. persons involved with foreign partnerships, enhancing the clarity, consistency, and compliance of such reporting.

Sources:
S Corporation Instructions for Schedules K-2 and K-3 (Form 1120-S) (2023)
IRS FAQ
Notice 2021-39
Instructions for Schedules K-2 and K-3 (Form 8865) (2023)
Partner’s Instructions for Schedule K-3 (Form 1065) (2023)
Partnership Instructions for Schedules K-2 and K-3 (Form 1065) (2023)
IRS FAQ