K-3 Exception for 2023 tax year
January 24, 2024 Update: The final instructions for Schedules K-2 and K-3 match the draft version of the instructions.
The IRS has indicated that it will continue to apply the domestic filing exception for eligible passthrough entities to avoid having to file Schedules K-2 and K-3 for the 2023 tax year. These schedules report information about foreign activities.
Even if an entity has no foreign activities, the IRS generally requires all entities to file Schedules K-2 and K-3 if the passthrough entity has any owner that claims the foreign tax credit on his or her personal income tax return, using Form 1116. However, beginning with the 2022 tax year, the IRS introduced the domestic filing exception to allow such entities that have no foreign activities to avoid preparing and filing Schedules K-2 and K-3.
According to the draft instructions for the 2023 versions of Schedules K-2 and K-3, the domestic filing exception will apply the same way as it did for the 2022 tax year. Entities that have no foreign activity, no foreign owners, and meet the proper notification requirements will continue to qualify for the domestic filing exception and thereby be able to avoid preparing and filing Schedules K-2 and K-3.
To meet the notice requirement, entities must include a notice with the Schedule K-1 sent to each owner that indicates that entity will not prepare or send a Schedule K-3 to the owner unless the owner requests Schedule K-3 from the entity. If entities e-file their returns before sending the notice to the owners, then there is no way that an owner request will cause the entity to have to file the Schedules K-2 and K-3 with the IRS for that year. If an owner makes such a request, then the entity must provide the Schedule K-3 to that owner in the current year, and it must provide Schedules K-2 and K-3 (for that owner) to the IRS in future years.
We previously discussed the domestic filing exception and certain other restrictions in the eligibility for that exception in our post on December 6, 2022.
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