Form K-2 Instructions and How to Use Your Schedule K-3

For individuals who invest in partnerships or S corporations with international dealings, Schedule K-3 is a document that reports items of international tax relevance. The Internal Revenue Service (IRS) introduced Form K-2 and the accompanying Schedule K-3 to create a standardized reporting format. These forms are attached to the tax returns of pass-through entities, like Form 1065 for partnerships or Form 1120-S for S corporations.

The purpose of these forms is to provide partners and shareholders with the information needed to complete their own tax returns, particularly for claiming foreign tax credits or deductions. The business entity files the comprehensive Form K-2 with the IRS. From that form, the entity generates a personalized Schedule K-3 for each owner reporting their share of the international amounts.

Understanding the Structure of Form K-2 and Schedule K-3

Part I: Partner and Shareholder Information

The initial section of Schedule K-3 details information about the pass-through entity, such as its name and Employer Identification Number (EIN). It also clearly identifies the partner or shareholder receiving the schedule. This part establishes the link between the business and its owner for tax reporting purposes.

Part II: Foreign Tax Credit Limitation

This part is for individuals who may claim a foreign tax credit on their personal returns using Form 1116, Foreign Tax Credit. Part II breaks down the owner’s share of the entity’s gross income by its source country. For example, if a partnership earned income from both Germany and Japan, this section would separately list the partner’s portion of income from each country.

The information is further organized by the category of income, such as passive or general limitation income, which corresponds to the categories on Form 1116. This detailed sourcing is necessary because the U.S. foreign tax credit is limited. The information from this part of the K-3 is entered on Part I of Form 1116.

Part III: Foreign Taxes

Part III works with Part II and is also used for completing Form 1116. This section reports the owner’s share of the foreign income taxes that the pass-through entity paid or accrued. The information is separated by country and income category, mirroring the structure of Part II.

An owner will see the foreign taxes reported in both the foreign currency and translated into U.S. dollars. These U.S. dollar amounts are what an individual will report on Part II of their Form 1116.

Other Key Parts

While Parts II and III are the most common for individual filers, other sections address more specific situations. Part IV provides information on allocating entity expenses, which partners may need to apportion between U.S. and foreign sources for the foreign tax credit calculation.

Other parts, such as V, IX, and X, provide information for other international tax forms related to foreign corporations, foreign branches, or foreign-derived intangible income. For most individual investors, these later sections may be blank unless their investment involves these more complex international structures.

The Domestic Filing Exception

Not every partnership or S corporation with foreign activity is required to complete Schedules K-2 and K-3. The IRS established a domestic filing exception for entities with minimal or no international tax consequences for their owners. To qualify, a domestic entity must meet a specific set of criteria.

• The entity must have no or only limited foreign activity. This is defined as having only passive category foreign income on which it paid or accrued no more than $300 of foreign income taxes.
• All direct partners or shareholders must be qualifying U.S. persons, such as U.S. citizens, resident aliens, or certain domestic estates and trusts.
• The entity must notify its owners that they will not receive a Schedule K-3 unless they request one. This notification can be attached to the owner’s Schedule K-1.
• No owner requests a Schedule K-3 by the deadline, which is one month before the entity files its tax return. For a calendar-year entity filing on extension, this date is August 15, 2025, for the 2024 tax year.

If an entity meets these conditions and no owner makes a timely request, it qualifies for the exception. However, if even one owner requests a K-3, the entity must provide the schedule to that owner.