Revised Schedule K2/K3 Filing Instructions

The IRS recently posted a revised draft version of the 2022 Partnership Instructions for Schedule K-2 and K-3 (Form 1065) and a similar revised version of the 2022 S Corporation Instructions for Schedules K-2 and K-3 (Form 1120-S). The key difference in these draft instructions from a first set of draft instructions for the forms posted in October 2022 is that new draft instructions modify the requirements to qualify for the domestic filing exception for filing and furnishing partnership and S corporation Schedules K-2 and K-3.

Domestic filing exception

The original draft instructions for 2022 partnership and S corporation Schedules K-2 and K-3, posted in October, contained a new exception to the requirement that partnerships and S corporations file and furnish the schedules for tax years beginning in 2022 (a similar exception was offered by the IRS in 2021 in Question 15 of the “Schedules K-2 and K-3 Frequently Asked Questions (Forms 1065, 1120S, and 8865)”). Partnerships would qualify for this domestic filing exception if:

1. The partnership has no or limited foreign activity;
2. The partnership’s direct partners are certain specified U.S. citizens/resident aliens;
3. Partners in the partnership receive a notification from the partnership by Jan. 15, 2023, stating that partners will not receive Schedule K-3 unless they request it; and
4. The partnership does not receive any 2022 Schedule K-3 requests by the one-month date, which is defined as one month before the due date (without extension) of the partnership’s Form 1065, U.S. Return of Partnership Income.

A similar domestic filing exception was included in the October draft instructions for S corporation Schedules K-2 and K-3, but it did not contain requirement number 2.

Changes to domestic filing exception in December draft Instructions

The domestic filing exception, with the same four general requirements, is retained in the new December draft partnership instructions for Schedules K-2 and K-3. However, certain specific details of the requirements have been modified in the new draft instructions.

The December draft instructions expand the list of allowable direct partners to include S corporations with a sole shareholder and certain single-member limited liability companies (LLCs) that are disregarded as an entity separate from their owner.

The December draft instructions also change the date the notification in requirement 3 must be provided to the partners. The date has been changed from Jan. 15, 2023, to, at the latest, when the partnership furnishes Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., to the partner, and the notice can be provided as an attachment to Schedule K-1.

In addition, the December draft instructions change the one-month date in requirement 4. The one-month date is now one month before the partnership files Form 1065. In the October draft instructions, the one-month date was one month before the due date (without extension) of the partnership’s Form 1065.

Similar changes to requirements 3 and 4 are included in the new December draft S corporation instructions for Schedules K-2 and K-3.

McGuire Sponsel’s Global Business Services team will continue to provide updates to this rapidly changing area. Please reach out to us if you have any questions or need assistance with compliance matters.