Qualifying for the Schedule K-2 Domestic Filing Exception

Schedules K-2 and K-3 are IRS forms used by partnerships and S corporations to report items of international tax relevance to their owners. These forms standardize the reporting of foreign-source income, deductions, and credits that owners need to calculate their U.S. income tax liability. The level of detail required can be a challenge for domestic businesses, so the IRS created filing exceptions for entities with limited or no foreign activity, allowing them to bypass these forms.

Qualifying for the Domestic Filing Exception

For tax years beginning in 2024, smaller entities are exempt from filing Schedules K-2 and K-3. A partnership or S corporation with total receipts of less than $250,000 and total assets under $250,000 at year-end is not required to file these forms.

For businesses that do not meet this small entity exception, the general domestic filing exception may still be an option if it meets other criteria. The primary test centers on the entity’s foreign activities. An entity generally qualifies only if it has no foreign activity, which includes foreign income taxes paid, foreign-source income, or ownership in foreign entities like corporations or partnerships.

The rules permit a small amount of foreign activity. An entity can qualify if its only foreign activity is passive category foreign income and it paid or accrued no more than $300 of foreign income taxes, shown on a payee statement. For example, a domestic partnership earning minor interest from a foreign bank account with less than $300 in foreign tax withheld might still qualify. However, owning stock in a foreign corporation or having a foreign branch would disqualify the entity.

In addition to the activity test, the entity’s ownership is reviewed. For a partnership to qualify, all its direct partners must be specific U.S. persons. For tax year 2024, eligible direct partners include:

• U.S. citizens or resident aliens
• Domestic decedent’s estates with only U.S. citizen or resident alien beneficiaries
• Certain domestic trusts with only U.S. citizen or resident alien grantors and beneficiaries
• S corporations

An S corporation seeking the exception must meet similar shareholder criteria, and the presence of any foreign person as a direct owner will prevent qualification.

The Partner and Shareholder Notification Requirement

In addition to the activity and ownership tests, an entity must notify its owners to be eligible for the domestic filing exception. This notification informs partners or shareholders that the entity will not provide a Schedule K-3 unless they request one. This step ensures that owners are aware of their right to receive this information if they need it for their own tax returns.

The notice must be furnished to the owner no later than when the entity provides their Schedule K-1 and can be sent as an attachment. This timing gives owners time to assess their needs and make a request if necessary.

The exception is voided for the entire entity if even one owner requests a Schedule K-3 by the deadline. The deadline for this request is one month before the partnership or S corporation files its tax return. For a calendar-year partnership filing on extension, this date could be as late as August 15, 2025.

A request is generally valid only for the tax year in which it is made, but an owner can make a standing request for all subsequent years. If a timely request is received, the entity must prepare and file Schedules K-2 and K-3 for all of its owners, not just the one who made the request.

Filing Requirements When the Exception is Not Met

When an entity does not qualify for a filing exception, either because it fails the initial criteria or because an owner requests a Schedule K-3, it must comply with the full filing requirements. It must prepare and submit Schedule K-2 with its annual tax return, either Form 1065 for a partnership or Form 1120-S for an S corporation. This schedule details the entity’s total amounts of international tax items, such as foreign tax credits and income sourced from various countries.

In conjunction with filing Schedule K-2, the entity must also furnish a Schedule K-3 to each of its partners or shareholders. Schedule K-3 breaks down the aggregate numbers from Schedule K-2 and reports each owner’s specific share of those items. This individual-level detail is what the partner or shareholder uses to complete their own tax return, for instance, when claiming a foreign tax credit on Form 1116.

The deadlines for these forms are tied to the entity’s main tax return. Schedule K-2 must be filed with the Form 1065 or 1120-S by its due date, including extensions. The Schedule K-3 must generally be furnished to owners by the same date.

If an owner requests a K-3 after the one-month deadline has passed, the entity is only required to provide the form to that specific owner. This is due on the later of the date the entity files its return or one month from the request date. Failure to file these forms correctly and on time can lead to penalties.