What Is Schedule K-3 for Form 1065?

Schedule K-3 is an Internal Revenue Service (IRS) form that accompanies Form 1065, the U.S. Return of Partnership Income. Its primary function is to report a partner’s individual share of items with international tax relevance that originate from the partnership’s operations. This form provides the detailed information necessary for partners to accurately complete their own tax returns, specifically concerning foreign tax credits and other international tax matters. It works in tandem with Schedule K-1, which reports a partner’s overall share of income, deductions, and credits.

Schedule K-3 is a supplementary form, expanding on the information traditionally provided on Schedule K-1. Introduced for tax years beginning in 2021, it standardizes the way partnerships report complex international tax information to their partners. This standardization helps by creating a clear and consistent format for these details, ensuring that partners have the necessary data to comply with U.S. international tax provisions.

Partnership Filing Requirements

The general rule from the IRS is that any partnership with items of international tax relevance must file Schedule K-2, which summarizes the partnership’s total international items, and Schedule K-3 for each partner. Items of international tax relevance can include a wide range of activities, such as having foreign source income, paying foreign taxes, or holding an ownership interest in a foreign corporation or partnership.

An exception exists that allows many domestic partnerships to avoid this filing requirement. This is known as the domestic filing exception. To qualify, the partnership must satisfy several specific criteria. The first condition is that the partnership has no or only limited foreign activity. Limited foreign activity is defined as having only passive category foreign income, on which no more than $300 of foreign income taxes were paid or accrued, and this information is shown on a payee statement like a Form 1099-DIV or 1099-INT.

Beyond the limited activity test, the partnership must also meet partner-level requirements. During the tax year, all direct partners must be U.S. citizens, resident aliens, domestic decedent’s estates, domestic grantor trusts, or certain other domestic entities. The partnership must notify its partners that they will not receive a Schedule K-3 unless they specifically request it. This notification can be attached to the partner’s Schedule K-1.

If all the preceding conditions are met, the final step for the exception is that no partner requests a Schedule K-3. A partner has until one month before the partnership files its Form 1065 to request the form. If a single partner requests the schedule by this deadline, the partnership is then obligated to complete Schedule K-3 for that partner. If no request is made and all other criteria are met, the partnership is relieved of the obligation to prepare and file Schedules K-2 and K-3.

Information Required for Schedule K-3

Compiling the information for Schedule K-3 requires a detailed breakdown of the partnership’s international financial activities. The partnership first completes Schedule K-2, which aggregates the total amounts for the entire entity, and then uses that information to prepare a Schedule K-3 for each partner, detailing their distributive share.

Part II of the form focuses on the Foreign Tax Credit Limitation. Here, the partnership must report the partner’s share of income and losses, sourced by country. This involves categorizing income into specific baskets, such as passive category income or general category income, as defined by U.S. tax law.

Part III delves into Other Information for the Foreign Tax Credit, providing a partner with their share of foreign taxes paid or accrued. This section requires the partnership to report the creditable foreign taxes and the corresponding income for each separate category. Other sections of the form address more specialized situations, such as information needed for a corporate partner to calculate its Foreign-Derived Intangible Income (FDII) deduction or details related to ownership in controlled foreign corporations (CFCs).

How Partners Use Schedule K-3

Upon receiving a Schedule K-3, a partner is equipped with the specific figures needed to handle the international components of their personal tax return. The form’s utility is in completing Form 1116, Foreign Tax Credit (for individuals, estates, and trusts), or Form 1118 for corporate partners. The detailed information on Schedule K-3 is designed to flow directly into these other forms, simplifying a complex calculation.

The data from Part II of Schedule K-3, which breaks down the partner’s share of income by source and category, is used to fill out the corresponding parts of Form 1116. The foreign source income reported on Schedule K-3 helps the partner determine the numerator of the foreign tax credit limitation formula, which restricts the amount of credit that can be claimed.

Similarly, the information in Part III of Schedule K-3, which details the foreign taxes paid or accrued on the partner’s behalf, provides the direct input for the section of Form 1116 where the partner claims the actual credit. The partner combines the information from Schedule K-3 with any other foreign income and taxes from other sources to determine their total foreign tax credit for the year.

The Filing Process for the Partnership

The IRS requires that Schedules K-2 and K-3 be filed electronically with the partnership’s Form 1065 return, typically as attached PDF files. This electronic filing mandate ensures the detailed information is processed efficiently.

The partnership must also furnish a copy of the completed Schedule K-3 to each partner by the deadline for the partnership’s tax return, including extensions. Timely delivery is important because partners depend on this information to file their own returns accurately. The partnership can deliver the schedule electronically or by mail, depending on its agreement with the partners.

Finally, the partnership should retain all records and workpapers used to prepare the schedules. The IRS may request this documentation during an examination to verify the accuracy of the reported international items.