Instructions for Form 1065 Schedule K-2

Schedule K-2, “Partners’ Distributive Share Items—International,” is an informational schedule attached to Form 1065, the U.S. Return of Partnership Income. It is designed to standardize the reporting of a partnership’s items with international tax relevance, such as foreign-sourced income or foreign taxes paid. This schedule works in tandem with Schedule K-3, “Partner’s Share of Income, Deductions, Credits, etc.—International.” While Schedule K-2 reports the partnership’s total international amounts, Schedule K-3 provides each partner with their specific share of those items, allowing them to complete their own tax returns, particularly Form 1116, Foreign Tax Credit.

Determining Your Filing Requirement

A partnership is required to file Schedules K-2 and K-3 if it has items of international tax relevance. This includes activities such as paying foreign income taxes, having foreign-source income, or holding interests in foreign entities. Even partnerships with no direct foreign activities might need to file if a partner claims a foreign tax credit, as the partner may require information from the partnership to complete their Form 1116. However, exceptions exist that exempt many partnerships from this requirement.

Beginning with the 2024 tax year, an exception is available for smaller partnerships. A partnership is not required to file Schedules K-2 and K-3 if it has both total receipts of less than $250,000 for the tax year and total assets of less than $250,000 at the end of the tax year.

Another provision that exempts many from this filing is the “Domestic Filing Exception.” To qualify, the partnership must meet four criteria:

• The partnership must have no or very limited foreign activity, restricted to passive category foreign income, and has paid or accrued no more than $300 in foreign income taxes.
• All direct partners must be U.S. citizens, resident aliens, certain domestic estates and trusts, or S corporations and other pass-through entities whose own direct partners also meet these criteria.
• The partnership must notify its partners, which can be done on Schedule K-1, that they will not receive a Schedule K-3 unless they request it.
• The partnership does not receive a request for Schedule K-3 from any partner by the “1-month date,” which is one month before the partnership files its Form 1065.

If all four conditions are met, the partnership is exempt from filing Schedules K-2 and K-3. If a request is made after the 1-month date, the partnership must still provide the K-3 to the requesting partner but is not required to file the schedules with the IRS.

Information Required for Schedule K-2

Preparing Schedule K-2 requires a detailed compilation of the partnership’s international tax data. The form itself is extensive, with up to 11 parts, though not all will apply to every partnership. Part I serves as a selection guide, indicating which other parts of the form the partnership must complete. It also requires reporting the partnership’s country of formation and the functional currency used for its books and records.

Part II focuses on the Foreign Tax Credit Limitation, which is necessary for partners who will claim a foreign tax credit. To complete this section, the partnership must source its gross income, distinguishing between U.S. source, foreign branch category, passive category, and other categories. It must also allocate and apportion deductions, such as interest expense and research and experimentation (R&E) expenses, against that sourced income.

Part III requires information related to other aspects of foreign tax credits. This includes reporting the total amount of foreign income taxes paid or accrued by the partnership, categorized by the type of income on which the tax was imposed. The partnership must provide details on each foreign tax, including the foreign country, the U.S. dollar amount, and the date paid or accrued.

Other sections of Schedule K-2 address more specialized international tax matters. Part IV gathers information relevant to the Foreign-Derived Intangible Income (FDII) deduction, which may apply if the partnership has corporate partners. Part V deals with distributions from foreign corporations, and Part X is dedicated to controlled foreign corporation (CFC) inclusions, such as Subpart F income and Global Intangible Low-Taxed Income (GILTI).

Completing and Distributing Schedule K-3

After determining the totals for Schedule K-2, the next step is to prepare and distribute Schedule K-3 to each partner. Schedule K-3 mirrors the structure of Schedule K-2 but reports each partner’s individual share of the international income, deductions, and credits. This process involves allocating the partnership-level totals from Schedule K-2 among the partners according to the partnership agreement.

The partnership is responsible for furnishing a completed Schedule K-3 to each partner. The deadline for providing this form is the same as the due date for the partnership’s Form 1065, including extensions. For a calendar-year partnership, this is March 15, or September 15 if an extension is filed.

Delivery of Schedule K-3 can be accomplished by mailing a paper copy to the partner’s last known address or by providing it electronically. For electronic delivery, the partnership must obtain the partner’s consent and use a secure portal or password-protected system to safeguard sensitive financial information.

Filing Schedule K-2 with the IRS

Schedule K-2 is not a standalone form and must be attached to the partnership’s Form 1065 when it is submitted. The method of submission depends on how the partnership files its tax return. For partnerships that file electronically, the tax preparation software will handle the integration of Schedule K-2 as a distinct attachment within the electronic filing package.

For partnerships that file a paper return, Schedule K-2 must be physically attached to the Form 1065. IRS instructions specify the proper order for assembling the return, and Schedule K-2 should be placed in the sequence of attachments directly after Schedule K-1.

Once filed, Schedule K-2 becomes part of the official tax record for the partnership for that year, and the IRS processes it along with the entire Form 1065 return. The data reported on the schedule is used for compliance and verification purposes, allowing the IRS to cross-reference the information with the amounts reported by the individual partners on their returns.