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What? Schedule K-2 and Schedule K-3 Coming in 2021? international-tax-sm.png

09 / 26 / 2020

Partnership entities (LLCs, LLPs, LLLPs, Ltd.s and other entities taxed as partnerships under the Federal tax laws and filing IRS Form 1065), including private equity funds, hedge funds, fund of funds, real estate funds, engery funds and venture capital funds) having items of international tax relevance (in general, certain specified non-US activities or non-US person partners) will be expected to complete Schedules K-2 and K-3, in addition to Schedule K-1 in 2021.  In July 2020, the IRS released for comment draft versions of the new Schedules K-2 and K-3.  These new schedules are designed to help partnerships report certain U.S. international tax information to their partners in a standard format.  www.taxnews.ye.com.  

Schedule K-2 (Form 1065), Partners' Distributive Share Items--International; and Schedule K-3 (Form 1065), Partner's Share of Income, Deductions, Credits, etc.--International, together with instructions for both the partnership and the partner have also been issued.  Apparently, the IRS plans similar revisions for Forms 1120-S and Form 8865- Return of U.S. Persons with Respect to Certain Foreign Partnerships.

Currently, these partnerships report international tax information within the various forms and schedules, but then have to pass supplemental information and statements, whitepaper disclosures, pro-forma forms, and footnotes to the Schedule K-1.  There is no standardized format.  Partners then struggle translating the information they get on these supplemental statements to report these international items properly.  Because the new Schedules K-2 and K-3 will put forth a standardized approach, including withholding and foreign source information and the U.S. international inclusion and foreign attributes relevant for domestic partners, the IRS hopes to more easily verify information.  

The new schedules would replace portions of the existing Schedule K-1, lines 16(a)-16(r), which will head to Schedule K-2, and Schedule K-3 will replace portions of the Sdhedule K-1, Part III, Boxes 16-20.  Schedule K-2 will act like a "return" and Schedule K-3 is the K-1 to that K-2.  9 sections of reporting is proposed:

Part I--Partnership's share of current year international transactions, such as foreign oil and gas taxes, splitter arrangements, high-taxed income, and Section 267A disallowed  deductions)

Part II- Foreign Tax Credit Limitations

Part III- Other information for preparation of Form 1116 or 1118

Part IV- Other foreign transaction information for U.S partners, including foreign-derived intangible income (FDII) and distributions from foreign corporations to partnerships

Part V- Controlled Foreign Corporation (CFC) and Global Intangible Low-Taxed Income (GILTI) inclusions

Part VI- PFIC and QEF Information (for Form 8621)

Part VII- Partners's share of partnership's interest in foreign corporation income (IRC Section 960)

Part VIII- Base Erosion and Anti-Abuse Tax (BEAT)((IRC Section 59A)

Part IX- Non-US foreign partners' character and source of income and deductions of the partnership (deductions, losses, gross income, and effectively connected income (ECI))

Other Forms 5471, 926 and 8621 will still remain to be prepared. Best practices will need to be adjusted to account for the time needed to prepare these streamlined forms, and agreements should anticipate issuance of these Schedules K-2 and K-3, and if needed, be updated.