Yesterday, I wrote a post stating the IRS was giving relief on the new Schedules K-2 and K-3. I did that because I believed what the IRS wrote. The IRS stated:
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.
Silly me, taking the IRS at their word. The IRS did indeed add an FAQ on Schedules K-2 and K-3 detailing the relief. That relief is noted in question 15, but if you read questions 10 – 12 that relief vanishes. The IRS in question 10 states they won’t penalize taxpayers who make a “good faith” effort to comply, but in question 11 notes the same rules that can require domestic-only entities to file Schedules K-2 and K-3:
In many instances, a partnership or S corporation with no foreign partners, foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3. For example, if the partner or shareholder claims the foreign tax credit, the partner generally needs certain information from the partnership on Schedule K-3, Parts II and III, to complete Form 1116. This information should have been reported in prior years, including before the Tax Cuts and Jobs Act, on the Schedules K and K-1, and is information the partner or shareholder needs to compute the foreign tax credit limitation, which determines the amount of foreign tax credit available to the partner or shareholder.
So the reality is that nothing has changed from Monday–there is no real relief at this point. I gave three examples of real relief yesterday: “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.” I would accept any of these (or something similar).
The problem is that I’ve dealt with the IRS in the past on “reasonable cause” issues with an international filing. A few years ago, clients of mine timely filed (with an extension) Forms 3520 and 3520-A related to a foreign trust. They mailed these forms using the equivalent of certified mail (neither of these forms can be electronically filed). A year after filing, they each received a $10,000 penalty notice for late filing. This made no sense; I had filed the extensions and had proof of that. We wrote the IRS noting this. One spouse had the penalties instantly removed. The other spouse had to go to Appeals over the same exact issue, and it took 30 months before the penalties were finally removed. (There was never an Appeals hearing–we just received a letter stating the penalties were removed.) The clients were under stress during those 30 months from a possible $10,000 penalty and were not happy.
I do not want my clients to face draconian penalties. Battling “reasonable cause” has been an adventure and I don’t think it will get better given that the IRS is drowning in paper.
The IRS also asked why tax professionals didn’t complain when the draft K-2 and K-3 forms and instructions were released last summer. That’s simple: We did not think we would be impacted. At that time, the instructions did not include any reference to a US-only entity with no foreign partners or operations needing to file these forms. The instructions were not changed on this until late January 2022. How do you expect tax professionals in July 2021 to know the IRS would change the rules in January 2022?
To the IRS: You need to offer real relief. This is already an awful (likely disastrous) Tax Season. Your actions on this matter do not inspire confidence.