IRS Gives Relief to Partnerships and S Corps Under Domestic Filing Exception

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The IRS has expanded the circumstances under which passthrough entities can avoid filing international reporting forms Schedules K-2 and K-3 with their tax returns. Specifically, the new rules broaden the domestic filing exception retroactive to 2024 for partnerships and S Corporations and add a new small entity exemption. The forms that are affected include:

Criteria for the Exception

To qualify for the exception, passthroughs must meet the following criteria:

Limited or No foreign activity. Limited activity is defined as passive category foreign income subject to not more than $300 of creditable foreign income taxes and that are shown on a payee statement.
Partners and shareholders must receive certain notices, including a notice of election to request a K-3 annually, and no requests before the one-month date (one month before return is filed).
All partners or shareholders fall into one of the categories below. Note that the new IRS rules allow qualification of domestic partnerships with direct partners that are included in the list below of individuals or entities qualified for the exception.
- U.S. persons
- resident aliens
- domestic decedents’ estates with solely U.S. citizen and/or resident alien individual beneficiaries
- domestic grantor trusts that are not foreign trusts and that have solely U.S. citizen and/or resident alien individual grantors and solely U.S. citizen and/or resident alien individual beneficiaries
- domestic non-grantor trusts with solely U.S. citizen and/or resident alien individual beneficiaries
- S corporations
- single-member limited liability companies, where the LLC is disregarded and the sole member is one of the other qualifying individuals

Small Entity Exceptions

The new rules also allow small entities and exemption from filing Forms K-2 and K-3. For partnerships, the Schedule M-3 rules for determination of status as a small partnership are used for the K-3 small entity filing exception. The partnership must meet the following conditions:

total receipts for the tax year were less than $250,000
total assets at the end of the tax year were less than $1 million
Schedules K-1 are filed with the return and furnished to the partners on or before the due date (including extensions) for the partnership return
the partnership is not filing and is not required to file Schedule M-3

For S Corporations, the eligibility criteria for the small entity filing exception are:

total receipts for the tax year were less than $250,000
total assets at the end of the tax year were less than $250,000

Observations

The expanded exceptions for filing Schedules K-2 and K-3 reduce the compliance burden on partnerships and S Corporations with limited foreign activities. They also make it easier for partners and shareholders to request Schedule K-3 information automatically for later years by eliminating the need for annual requests. Small entities also benefit by being exempt from the K-2 and K-3 filing requirements. The new rules are a welcome change which should help minimize filing requirements and help taxpayers avoid technical errors when filing their annual returns.