Understanding Updates to Schedules K-2 and K-3 Reporting

Navigating ongoing changes in international tax can feel daunting, especially when new compliance requirements arrive that fundamentally shift established processes. For many partnerships and S corporations, the introduction of Schedules K-2 and K-3 has quickly become a top concern. The stakes are high—these forms are not just bureaucratic checkboxes, but critical for keeping pace with evolving IRS expectations. Falling behind can expose entities to penalties, but understanding the landscape can prevent costly missteps and give confidence when reporting cross-border activities.

Much of the anxiety comes from the complexity and novelty of these forms. Who actually needs to file, what prompted the change, and how can accountants or finance managers demonstrate they've met the IRS’s vague-sounding benchmarks for 'good faith'? Below, the latest guidance is broken down into clear steps and explainers to help ensure no important detail is missed.

Who Needs to File Schedules K-2 and K-3

Both Schedule K-2 and Schedule K-3 play distinct roles in international tax reporting. Schedule K-2 is filled out at the entity level—by a partnership, S corporation, or certain filers of Form 8865—when the entity is involved directly or indirectly in foreign activities. Schedule K-3 breaks out each individual partner’s or shareholder’s allocation of these international items and is provided to those individuals.

Entities required to use these schedules generally include:

• Domestic partnerships and S corporations that engage in international activities
• U.S. persons who must file Form 8865 due to involvement with a controlled foreign partnership, foreign partnership transfers, or other specified changes in interests

The detailed instructions for these schedules emphasize the importance of correctly distributing relevant information to each partner or shareholder. For those needing in-depth instruction, Checkpoint’s Federal Tax Coordinator (on the Form 1065 side), and guidance on S corporation reporting, are available for deeper exploration.

Key Drivers Behind the New International Reporting Forms

What spurred the rollout of Schedules K-2 and K-3? The major catalyst was the expansion of international tax rules in the wake of the 2017 Tax Cuts and Jobs Act. Provisions such as global intangible low-taxed income (GILTI), the base erosion and anti-abuse tax (BEAT), and the foreign derived intangible income (FDII) regimes led to a dramatic increase in the complexity and scope of reporting required for entities with cross-border activity. For details on these concepts, the GILTI explanation is a useful resource.

Prior to these updates, inconsistencies and gaps in international information flows often frustrated both the IRS and taxpayers. The new schedules were designed to standardize disclosures and create clearer lines of responsibility, which is especially important as international arrangements become more common and more scrutinized.

Penalty Relief for 2021 Filings

Recognizing that the transition to these new forms could pose a heavy lift—especially for partnerships or S corporations with substantial foreign activities—the IRS provided penalty relief for 2021. Specifically, under Notice 2021-39, filers were shielded from penalties that would otherwise apply under Code sections 6698, 6699, 6721, 6722, and 6038(b)–(c) for mistakes or omissions if they could demonstrate a good faith effort to comply.

Factors the IRS considers when evaluating this standard include whether the filer made changes to data collection systems and communication procedures, efforts to obtain information from partners or shareholders, and steps taken to revise governing instruments to facilitate necessary disclosures. Simply put, the IRS expects organizations to show proactive attempts at compliance—even if perfect information wasn’t available.

What Qualifies as a Good Faith Reporting Effort

The 'good faith' standard is not a free pass, but it does acknowledge the limits of what’s possible in the first year of implementation. When considering eligibility for relief, both the diligence taken to reach out to partners and the reasonableness of any assumptions made in the absence of clear information will be weighed.

For example, if a partnership has a direct or indirect foreign partner, it must address the corresponding sections of Schedules K-2 and K-3. If efforts to collect information are unsuccessful, documentation describing these attempts will help support a claim of good faith. The IRS also differentiates between managing partners or those with significant holdings versus minority partners—expecting greater diligence where influence and access exist.

Further insight can be found in Checkpoint’s Tax Planning and Advisory Guides and related LLC guidance, which provide more granular analysis on due diligence obligations.

Expanded Exceptions and Additional IRS Guidance

In response to practitioner feedback and ongoing questions, the IRS and Treasury offered additional flexibility in 2022. Through updates to FAQs, select domestic partnerships and S corporations received a possible exception from the 2021 filing requirements for Schedules K-2 and K-3 if certain conditions are met:

• No direct partners are foreign partnerships, corporations, individuals, estates, or trusts for 2021
• No foreign source activities, taxes paid, or ownership of assets likely to generate foreign income
• No requests or need for specified international information for 2020 or 2021

If these criteria are satisfied, the entity is generally not required to file these schedules—unless a partner or shareholder subsequently requests Schedule K-3 info (in which case the full reporting obligation applies). Review current FAQ guidance to verify eligibility and seek clarifications not present in the formal instructions.

Resources for Navigating Schedules K-2 and K-3

Given the stakes and nuances involved, continued professional education is critical. Beyond the cited checklists and guidance above, staying current with official FAQ updates and regularly reviewing the latest form instructions should be part of every practitioner’s process. The links to Checkpoint’s Federal Tax Coordinator and topic-specific IRS FAQ updates provide a solid foundation for adapting as the landscape continues to evolve.