What is the purpose of Schedules K-2 and K-3?
The schedules were designed to give the IRS more detailed information about the foreign transactions of partnerships. They are an expansion of the Foreign Transactions section of Schedule K (page 4) of Form 1065.
Why are these forms generated?
Beginning in tax year 2021, the IRS requires that partnerships include Schedule K-2 as well as all partners’ Schedules K-3 with their full Form 1065 filing. In addition, each partner must now receive their own Schedule K-3 (along with their Schedule K-1 and K-1 instructions sheet).
While these new schedules are designed to report foreign source income to the IRS, they are required to be filed by all partnerships, even those that had no foreign source income in the tax year.
According to IRS regulations, individual taxpayers who wish to claim a credit on IRS Form 1116 for foreign taxes withheld over certain amounts will need the information contained on Schedule K-3. (Individual partners should see IRS instructions for Form 1116 for details or contact their tax professional.) Due to the possibility that individual members may file IRS Form 1116, Schedules K-2 and K-3 are generated for all clubs and for all members.
These new schedules are each 20 or more pages in length, so a complete printed return for a 12-member club could total more than 400 pages. We suggest e-Filing using the myICLUB.com Club Tax Printer to save on printing and postage costs.
How do we know if one of our securities is a foreign investment?
The Internal Revenue Service defines a foreign company as any company that is not a US company; generally this is determined by its country of incorporation. The country of incorporation may not always be the same as the location of its headquarters, or the country in which it primarily operates. You can find the country of incorporation in some the company’s SEC or other regulatory filings, or directly from the company via its investor relations website. While you may find similar information from other sources, the company itself, and the SEC filings are the most reliable source of information.
Do not assume the country of incorporation for any security that your club owns. For instance, many “Chinese” companies are not actually incorporated in China.
American Depository Receipts (ADRs) and American Depository Shares (ADSs) are shares of non-U.S. companies that trade on U.S. exchanges, and are considered foreign companies.
The portion of distributions made by a mutual fund or exchange traded fund (ETF) that holds foreign securities must also be reported.
How do we mark a security as foreign?
Sign in to your club, and go to Accounting > Securities > Update security settings. Click the Pencil button next to the security name. On the next page, use the Country drop-down, to select the country of incorporation. Click Submit to save the changes.
If you have already performed the Allocation of Income and Expenses for the tax year, make sure to do that again after changing the Country of a Security, then the taxes can be regenerated.
What if we choose the wrong country, list a foreign security as a U.S. one, or a U.S. security as foreign?
At least for tax year 2021, nothing. Our reading of the IRS documentation is that they will be lenient in enforcement regarding the new schedules for 2021 returns.
Who gets which forms?
The Schedule K-2 is included with the Form 1065 filed with the IRS. If the club mails in the 1065, the complete Schedule K-2 should be included along with a copy of each partner’s Schedule K-3.
The Schedule K-3 is treated like the Schedule K-1. Each partner must be given a copy of their Schedule K-3. If members are downloading or printing forms, they will want to include a copy of the K-3. The K-3 is included with the K-1 when using the “Download my K-1” link in the Taxes tab in myICLUB by each partner of the club.
Why is most of my Schedule K-2 and/or K-3 blank?
This is normal. Both the Schedule K-2 and K-3 are designed to cover a wide range of possibilities and will be largely blank for most investment clubs. Only Parts II and III will have any values for typical investment clubs, while Parts I and Parts IV to XIII will be blank. Schedules generated by myICLUB.com will typically include details of the information reported in Parts II and III on separately-attached Supplements.
Why does the Supplement for Part III not list the name of the company, just a two letter code?
This is normal. Part III is only concerned with which country the money came from.
Why does the “Type of Tax” column in the Part III Supplement just say WHTD?
WHTD is the IRS’s code for “Withholding Tax on Dividends,” and is a reference to money that was withheld (taxed) by a foreign government.
Our club already filed, before the change to include these forms for everyone. Do we need to re-file?
This is a personal choice, and if the club does decide to re-file, you can easily e-file an amended return in myICLUB. That said, we believe it highly unlikely the IRS would want to spend the resources going after small partnerships with relatively insignificant foreign financial involvement. These new schedules were designed primarily for more sophisticated partnerships with foreign financial transactions.