The Internal Revenue Service (IRS) has issued significant revisions to the filing exceptions for Schedules K-2 (Partners’ Distributive Share Items—International) and K-3 (Partner’s Share of Income, Deductions, Credits, etc.—International) for both Form 1065 (U.S. Return of Partnership Income) and Form 1120-S (U.S. Income Tax Return for an S Corporation) for tax year 2024. These changes aim to expand the applicability of certain domestic filing exceptions and introduce new small entity exceptions, potentially reducing compliance burdens for many entities. A thorough understanding of these updated requirements is crucial for practitioners navigating the international tax landscape for pass-through entities.

These changes are outlined on the following IRS web pages:

Prior to these recent changes, a domestic partnership was generally exempt from completing and filing Schedules K-2 and K-3, or furnishing Schedule K-3 to a partner (unless requested after the 1-month date), if four specific criteria were met and the partnership was not a Qualified Derivatives Dealer (QDD) partnership.

Revisions to Form 1065, Schedules K-2 and K-3 Filing Requirements for Partnerships

The IRS has now expanded the domestic Schedule K-2 and Schedule K-3 filing exception and created a new small partnership Schedule K-2 and Schedule K-3 filing exception for Form 1065.

Expanded Domestic Filing Exception for Partnerships

For a domestic partnership to qualify for the expanded domestic filing exception for its 2024 tax year, it generally still needs to satisfy criteria related to foreign activity, partner notification, and the absence of K-3 requests by the 1-month date, with a significant expansion to the partner types allowed:

No or Limited Foreign Activity: During the 2024 tax year, the domestic partnership must either have no foreign activity, or if it does, such activity must be limited to passive category foreign income upon which not more than $300 of foreign income taxes are treated as paid or accrued by the partnership. This income and taxes must be shown on a payee statement furnished or treated as furnished to the partnership.
- Foreign activity is broadly defined to include foreign income taxes paid or accrued, foreign source income or loss, or ownership interest in foreign partnerships, foreign corporations, foreign branches, or foreign disregarded entities.
U.S. Citizen/Resident Alien Partners (Expanded Definition): All direct partners in the domestic partnership during tax year 2024 must fall into an expanded list of U.S. persons. This includes:
- Individuals who are U.S. citizens or resident aliens.
- Domestic decedents’ estates with solely U.S. citizen and/or resident alien individual beneficiaries.
- Domestic grantor trusts with solely U.S. citizen and/or resident alien individual grantors and beneficiaries.
- Domestic non-grantor trusts with solely U.S. citizen and/or resident alien individual beneficiaries.
- S corporations.
- Single-member Limited Liability Companies (LLCs) disregarded as entities separate from their owners, where the sole member is one of the aforementioned persons.
- Crucially, this expanded definition now also includes domestic partnerships whose direct partners themselves consist solely of the aforementioned U.S. individuals, estates, trusts, S corporations, or disregarded single-member LLCs.
Partner Notification: If criteria related to foreign activity and U.S. citizen/resident alien partners are met, the partnership must provide a notification to partners by the time Schedule K-1 is furnished. This notice, which can be an attachment to Schedule K-1, must inform partners that they will not receive Schedule K-3 unless they request it.
No 2024 Schedule K-3 Requests by the 1-Month Date: The partnership must not receive any requests for Schedule K-3 information from any partner on or before the 1-month date. The 1-month date is one month before the date the partnership files Form 1065. For tax year 2024 calendar year partnerships, this date is August 15, 2025, if the partnership files an extension. Any request for Schedule K-3 information for a prior year will also be considered a request for the 2024 tax year.

New Small Partnership K-2/K-3 Filing Exception

In addition to the expanded domestic filing exception, a new small partnership exception has been created. This exception generally aligns with the conditions found in Form 1065, Schedule B, Question 4, which exempts a partnership from completing Schedules L, M-1, and M-2, and certain items on Form 1065 and Schedule K-1.

A partnership is generally exempt from filing Schedules K-2 and K-3 if it meets all four of the following conditions:

The partnership’s total receipts for the tax year were less than $250,000.
The partnership’s 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.

Similar to the domestic exception, for a partnership meeting these small partnership conditions, partners must receive a notification no later than when Schedule K-1 is furnished, stating that they will not receive Schedule K-3 unless requested.

Implications of K-3 Requests for Partnerships

If a partnership qualifying under either the expanded domestic exception or the new small partnership exception receives a request for Schedule K-3 information from any partner on or before the 1-month date, the partnership is required to file the tax year 2024 Schedules K-2 and K-3 and furnish Schedule K-3 to the requesting partner(s).

However, if a request for Schedule K-3 information is received after the 1-month date (and no other requests were received on or before the 1-month date), the partnership is not required to file the tax year 2024 Schedules K-2 and K-3 or furnish Schedule K-3 to non-requesting partners. In this scenario, the partnership is still obligated to provide the requested Schedule K-3 to the requesting partner on the later of the Form 1065 filing date or one month from receiving the request.

It is important to note that Schedules K-2 and K-3 are required to be completed only for the parts and sections relevant to the requesting partner. For instance, if a partner requests information from Part III, Section 2, the partnership only needs to complete and file Schedule K-2, Part III, Section 2 (for partnership assets) and Schedule K-3, Part III, Section 2 (for the partner’s share). No other parts or sections need to be filed or furnished to the IRS or other partners.

If requests are received both on or before and after the 1-month date, the full filing requirement for K-2/K-3 applies only to those requests received on or before the 1-month date. For later requests, the partnership must still provide the specific K-3 information to that partner.

Partners generally must request Schedule K-3 information annually, unless a specific request is made for the current and all subsequent tax years.

Revisions to Form 1120-S, Schedules K-2 and K-3 Filing Requirements for S Corporations

Similar to partnerships, the IRS has also updated the instructions for Form 1120-S, Schedules K-2 and K-3, for tax year 2024, focusing on modifications to the "1-month date" rule for the domestic filing exception and introducing a new small S corporation filing exception.

Domestic Filing Exception for S Corporations: Updates to the 1-Month Date Rule

While the full criteria for the domestic filing exception for S corporations are not exhaustively detailed in the provided sources, the updates specifically address the "No 2024 Schedule K-3 requests by the 1-month date" criterion. The 1-month date for S corporations is one month before the date the S corporation files the Form 1120-S. For tax year 2024 calendar year S corporations, this date is also August 15, 2025, if the S corporation files an extension.

If an S corporation receives a request for Schedule K-3 information after the 1-month date for tax year 2024, and no other requests were received on or before the 1-month date, the domestic filing exception is considered met. In this case, the S corporation is not required to file the tax year 2024 Schedules K-2 and K-3 with the IRS or furnish Schedule K-3 to non-requesting shareholders. However, the S corporation must still provide the completed Schedule K-3 with the requested information to the requesting shareholder on the later of the Form 1120-S filing date or one month from the request receipt date.

An alternative exemption, the Form 1116 exemption, may be applicable if the domestic filing exception is not met.

New Small S Corporation Filing Exception

A new small S corporation filing exception has been introduced, linked to the conditions of Form 1120-S, Schedule B, Question 11, which generally exempts an S corporation from completing Schedules L and M-1.

An S corporation is excepted from completing Schedules K-2 and K-3 if it meets both of the following conditions from Question 11 of Schedule B:

The corporation’s total receipts for the tax year were less than $250,000.
The corporation’s total assets at the end of the tax year were less than $250,000.

For an S corporation meeting these conditions, shareholders must receive a notification no later than when Schedule K-1 is furnished, stating that they will not receive Schedule K-3 unless requested.

Implications of K-3 Requests for S Corporations

If an S corporation qualifying under the small S corporation exception receives a request for Schedule K-3 information from any shareholder on or before the 1-month date, the S corporation is required to file the tax year 2024 Schedules K-2 and K-3 and furnish Schedule K-3 to the requesting shareholder(s).

Similar to partnerships, if a request is received after the 1-month date (and no other requests were received on or before the 1-month date), the S corporation is not required to file the tax year 2024 Schedules K-2 and K-3 or furnish Schedule K-3 to non-requesting shareholders. The S corporation must still provide the requested Schedule K-3 to the requesting shareholder on the later of the Form 1120-S filing date or one month from receiving the request.

Schedules K-2 and K-3 are only required to be completed for the parts and sections relevant to the requesting shareholder. The S corporation is not required to complete, attach, file, or furnish any other parts or sections of Schedules K-2 and K-3 to the IRS, the requesting shareholder, or any other shareholder.

Should an S corporation receive requests from shareholders both on or before and after the 1-month date, the filing requirement for the full K-2/K-3 applies only to those requests received on or before the 1-month date. For requests received after the 1-month date, the S corporation must provide the specific K-3 information to that shareholder.

A shareholder generally must request Schedule K-3 information for each year, unless a specific request is made for the current and all subsequent tax years.

Conclusion

These revisions to the Schedules K-2 and K-3 filing exceptions for tax year 2024 represent a significant shift designed to alleviate some compliance burdens for domestic and small pass-through entities. Practitioners must carefully review each client's specific circumstances against these updated criteria, paying close attention to the definition of "foreign activity," the expanded types of eligible partners/shareholders, the revenue and asset thresholds for the new small entity exceptions, and the critical "1-month date" for K-3 requests. Proactive communication with partners and shareholders regarding K-3 notification and request procedures will be key to ensuring compliance and avoiding unnecessary filings.

Prepared with assistance from NotebookLM.