The IRS surprised tax return preparers when they issued revised instructions for 2021 partnership and S corporation tax returns during the week ended February 4, 2022. According to the new instructions, domestic partnerships (including most LLCs) and S corporations must include new 2021 Schedules K-2 and K-3, reporting the owner’s share of international transactions, even when the entity had no foreign activities.
The reason for the requirement is information for passthrough entities is required to correctly complete 2021 Form 1116, Foreign Tax Credit.
If the tax return preparer knows that none of the owners will file Form 1116 for 2021, Schedules K-2 and K-3 don’t have to be completed and submitted for the entity. Most taxpayers who have investments in mutual funds will have foreign tax credit information to report.
Although Schedules K-2 and K-3 are massive, the information required to be reported for entities that only have domestic operations is minimal.
Note that Schedules K-2 and K-3 can’t be efiled at this time. PDFs of the forms can be attached to an efiled return..
Hopefully the IRS will revisit these forms so they won’t be required required for businesses that only have domestic operations in the future. Right now, a passthroough entity could be subject to failure to file penalties (filing an incomplete income tax return) when they aren’t included.