IRS adds and expands schedule K-2 and K-3 exceptions

The IRS published new and expanded filing exceptions on June 4 for schedules K-2 and K-3 for partnerships and S corporations.

The post-release changes to the instructions include an expansion of the so-called “domestic filing exception” and a new exception for “small” partnerships and S corporations. The changes also indicate that partners and shareholders must request a Schedule K-3 for each year, unless the partner or shareholder specifically requests to receive Schedule K-3 information automatically for each subsequent year.

Expanded domestic filing exception: Beginning for tax year 2024, the IRS is expanding Criterion 2 of the existing domestic filing exception for partnerships. Previously, Criterion 2 required “[a]ll direct partners in the domestic partnership” to be certain persons, including U.S. citizens/resident aliens. Under Criterion 2 in the instructions, the U.S. citizens/resident aliens who are allowed to be direct partners were: (a) individuals that are U.S. citizens; (b) individuals that are resident aliens; (c) domestic decedent’s estates with solely U.S. citizen and/or resident alien individual beneficiaries; (d) domestic grantor trusts that are not foreign trusts as defined in Section 7701(a)(31)(B) and that have solely U.S. citizen and/or resident alien individual grantors and solely U.S. citizen and/or resident alien individual beneficiaries; (e) domestic nongrantor trusts with solely U.S. citizen and/or resident alien individual beneficiaries; (f) S corporations (extended to include any S corporation, not just S corporations with a sole shareholder); or (g) single-member LLCs, where the LLC’s sole member is one of the persons in (a) through (f), and the LLC is disregarded as an entity separate from its owner.

In the post-release change published on the IRS website, the IRS indicated that it is expanding Criterion 2 to now include direct partners who are partnerships (upper-tier partnerships) with direct partners who also meet criterion 2 (i.e., other pass-through entities that have only persons described in (a) through (g) of criterion 2 above).

The partnership must still meet the other criteria included in the existing domestic filer exception (e.g., the partnership must have either no or limited foreign activity, meet the notification requirements, etc.).

As noted above, the IRS amended the list of eligible partners to include any S corporation (not just S corporations with a sole shareholder).

Small partnership and S corporation exception: Beginning with tax year 2024, partnerships and S corporations with total receipts for the tax year of less than $250,000 and total assets at the end of the tax year of less than $250,000 are no longer required to file Schedules K-2 or K-3. This may include any partnership that answered "Yes" to Question 4 on Schedule B of Form 1065 and any S corporation that answered "Yes" to Question 11 on Schedule B of Form 1120-S.

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