Will the IRS penalize taxpayers who exercise a good faith effort to comply with Schedules K-2 and K-3 for 2021 but struggle due to the difficulties in implementing the new schedules

No, the IRS will not penalize taxpayers who exercise a good faith effort to comply with Schedules K-2 and K-3 for 2021 but struggle due to the difficulties in implementing the new schedules. According to IRS Notice 2021-39, taxpayers who make a good faith effort to comply with the new reporting requirements for Schedules K-2 and K-3 will not be subject to penalties for any incorrect or incomplete reporting for the 2021 tax year.

The IRS has provided transition relief for tax years beginning in 2021, recognizing that filers may not have systems or procedures in place to obtain all necessary information about their partners, shareholders, or controlled foreign partnerships. To qualify for this relief, the filer must establish to the satisfaction of the IRS that they made a good faith effort to comply with the filing and furnishing requirements prescribed in the instructions to Schedules K-2 and K-3.

In determining whether a filer has made a good faith effort, the IRS will consider several factors, including:

• The extent to which the filer has made changes to its systems, processes, and procedures for collecting and processing relevant information.
• The extent to which the filer has obtained information from partners, shareholders, or the controlled foreign partnership, or applied reasonable assumptions when information is not obtained.
• The steps taken by the filer to modify the partnership or S corporation agreement or governing instrument to facilitate the sharing of information with partners and shareholders.

If a filer does not establish that they made a good faith effort to comply with the new requirements, they will not be eligible for penalty relief under this notice.

Sources:
Notice 2021-39
Instructions for Form 1065 (2023)
Instructions for Form 1120-S (2023)
Mission Impossible: Making Schedules K-2 and K-3 (Relatively) Painless
IRS Feels Your Pain on Schedules K-2 and K-3
Transition Relief Provided for Partnership Reporting Penalties