IRS: “You Know That New K-2/K-3 Requirement: Well, We Had Second Thoughts.”

UPDATE: Make sure you read the post of February 17, 2022 on this issue.

Every so often the IRS actually listens to the tax professional community.  Tax professionals were unanimous in stating that requiring a domestic partnership with no foreign partners and no foreign operations to complete the new Schedules K-2 and K-3 was stupid; it’s similarly stupid for an S-Corp with no foreign operations.  (I wrote about this requirement 11 days ago.)  The IRS added the following notice to a special page on the 2022 Tax Season:

Coming relief from certain Schedule K-2 and K-3 reporting: The IRS intends to provide certain additional transition relief for this year from the Schedule K-2 and K-3 reporting for certain domestic partnerships and S corporations with no foreign activities, foreign partners or shareholders, and without knowledge of partner or shareholder need for information on items of international relevance. For 2021, these qualifying domestic partnerships and S corporations will not have to file the new schedules. We are taking this step in response to feedback we received from the tax community and our stakeholders. The IRS will provide full details of this relief soon.

It;s great that the IRS realized the problems that these new schedules involve for tax professionals and taxpayers during what is sure to be a challenging Tax Season.  However, there’s still a long-term problem that needs to be resolved.

Consider Harry, a partner in a domestic partnership (call it Acme) with no foreign partners and no foreign operations.  He and his wife typically have about $400 of foreign tax paid through a different partnership he’s a partner in.  He tells the managing member of Acme that for 2022 (next year’s taxes filed in 2023) he doesn’t have a Form 1116 filing requirement.  Acme timely files its 2022 return and doesn’t include Schedules K-2 and K-3.  In September, Harry receives the other partnership’s K-1, K-2, and K-3 and discovers that this year there was $610 of foreign tax paid.  Does Acme now have to amend its 2022 returns?  Is Acme subject to draconian penalties even though the partner had no way of knowing about the Form 1116 requirement? 

There are three courses of action the IRS should choose among for the long-term resolution of the issue.  They could just use a de minimis threshold of somewhere between $1 million and $25 million of sales; entities with sales below that and no foreign partners and foreign operations would be exempt.  The IRS could base whether Schedules K-2 and K-3 need to be filed on the prior year’s requirements for filing Form 1116.  Or the IRS could just drop the requirement to file these forms for domestic entities with no foreign partners or operations.

Unfortunately, I suspect all that’s happened is the problem has been postponed one year.

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