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The Most Frequently Asked IRS Questions Regarding… Short Tax Year Pass-Through Entity Returns, Schedules K-2 and K-3



Schedules K2 And K3

Background

In summer 2021, the Treasury Department and the IRS finalized Schedules K-2 and K-3 for Forms 1065, 1120-S, and 8865 (“Forms”) for tax year 2021. The schedules are designed to provide greater clarity for partners and shareholders on how to compute their U.S. income tax liability with respect to items of international tax relevance, including claiming deductions and credits. The Treasury Department and the IRS also finalized instructions associated with the Schedules K-2 and K-3. The tax year 2021 Forms, to which Schedules K-2 and K-3 must be attached, have not yet been finalized. Questions have arisen whether the Schedules K-2 and K-3 must be attached to tax year 2020 Forms for partnerships or S corporations with 2021 short tax years; or, in the case of Form 8865, filers of Form 8865 with 2021 short tax years. These FAQs address questions concerning Schedules K-2 and K-3 with respect to 2021 short tax years for pass-through entities and filers of Form 8865.

Questions

1. Are the Schedules K-2 and K-3 required to be attached to the Forms for the 2021 short tax years? (added December 7, 2021)

A. Final version of tax year 2021 Forms not available at least 30 days before the return due date. A 2021 short tax year is a tax year that begins on or after January 1, 2021, and is less than 12 months because the pass-through entity (or in the case of Form 8865, the filer of Form 8865) either is not in existence for an entire tax year or its tax year changes. With respect to a 2021 short tax year that begins and ends in 2021, if the final version of the tax year 2021 Forms (including the Schedules K and K-1) are not available at least 30 days before the due date of the return (or, in the case of Form 8865, not available at least 30 days before the filer’s return is required to be filed), tax year 2020 Forms must be filed and must incorporate any tax law changes that are effective for the 2021 tax year. If final tax year 2021 Forms and instructions are not available at least 30 days before the tax year 2021 return is required to be filed (or, in the case of Form 8865, not available at least 30 days before the filer’s return is required to be filed), then you will not be subject to penalties for failing to attach Schedules K-2 and K-3 to the tax year 2020 Forms. See Notice 2021-39, 2021-27 I.R. B. 3, for reporting requirements, applicable penalties and transition relief from penalties. The Notice will apply with respect to information that would have been reported on the Schedules K-2 and K-3, but that is provided by completing the tax year 2020 Forms with attachments as described below. Also, you will not be subject to penalties for failing to attach Schedule K-3 to the Schedule K-1 provided to the partner or shareholder. Filers must follow the instructions for the tax year 2020 Forms relating to reporting international transactions and items of international tax relevance on Schedules K and K-1, with required attachments, and include the information required by Schedules K-2 and K-3 and the instructions for those schedules. If you choose, you may attach Schedules K-2 and K-3 (in pdf format) to the tax year 2020 Forms, and these schedules should be completed by following the tax year 2021 instructions for those schedules. If Schedules K-2 and K-3 (in PDF format) are attached, you do not need to complete line 16 of the Form 1065 and Form 8865, Schedules K and K-1, and line 14 of the Form 1120-S, Schedules K and K-1, the tax year 2020, except for:

  • Form 1065, Schedule K, line 16p, and Schedule K-1(Form 1065), line 16. Codes P and Q;
  • Form 8865, Schedule K, line 16p, and Schedule K-1(Form 8865), line 16, Codes P and Q;
  • Form 1120-S, Schedule K, line 14p, and Schedule K-1(Form 1120-S), line 14, Codes P and Q.

See Notice 2021-39, 2021-27 I.R. B. 3, for reporting requirements, applicable penalties and transition relief from penalties. Unless you qualify for relief under this Notice, you may still be subject to a penalty for failing to show all information required.

2. When are the Schedules K-2 and K-3 required to be attached to the Forms? (added December 7, 2021)

A. Final version of tax year 2021 Forms available at least 30 days before the return due date. If the tax year 2021 Forms are available at least 30 days before the filing due date, the tax year 2021 Forms must be filed and Schedules K-2 and K-3 are required to be attached to the returns for partnerships and S corporations (or, in the case of Form 8865, the filers of Form 8865) that have an annual accounting period beginning on or after January 1, 2021. The exception from filing Schedules K-2 and K-3 explained in question 1 ONLY applies to 2021 short tax years for which returns are due 30 days or less from when the tax year 2021 Forms become available (or, in the case of Form 8865, question 1 only applies to 2021 short tax year returns of filers of Form 8865 that are due 30 days or less from when the tax year 2021 Form 8865 becomes available).

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