According to Law360, the world of international tax reporting has grown more complicated. In addition to the general globalization in business, the 2017 Tax Cuts and Jobs Act made significant changes to the international tax landscape.
The TCJA introduced the base erosion and anti-abuse tax, global intangible low-taxed income, foreign derived intangible income, and the participation exemption regime. These new international tax rules, coupled with an already complicated U.S. tax system, make tax compliance a daunting task for even the most sophisticated companies and investors.
Navigating this landscape has become particularly complicated for investors in pass-through entities that rely on Schedule K-1, used to report a partner's share of income, deductions credits and other items, to comply with their U.S. income tax reporting requirements. The way international tax items were reported on Schedule K-1 historically lacked structure — often leaving investors to sort through lengthy footnotes that were inconsistent in presentation from one investment to the next.
In response to this problem, the Internal Revenue Service released Schedule K-2, for reporting a partner's international distributive share items, and Schedule K-3, for reporting a partner's share of international income, deductions, credits, etc., on June 3 and June 4, along with corresponding forms related to Form 1120-S.
The schedules are designed to provide greater clarity for pass-through investors on how to compute their U.S. income tax liability with respect to items of international tax relevance — generally foreign activities or foreign partners.
Schedules K-2 and K-3, along with accompanying instructions, will affect taxpayers filing Form 1065, which is used to report partners' share of income and other items; Form 1120-S, which reports U.S. income tax for an S corporation; and Form 8865, which is used to report the income of foreign partnerships for the 2021 tax year.
The recent release of the final forms and instructions provides valuable insight into the future of reporting for international tax matters for pass-through entities. The compliance season for 2021 returns is fast approaching. Taxpayers should take advantage of the availability of the final forms and accompanying instructions — albeit some may be in draft form — as an opportunity to assess their ability to comply with the additional reporting they entail.
Taxpayers should also make any needed changes to their tax compliance processes and systems to best enable themselves to comply with the additional reporting.
Go to Law360 for more on an overview of the new reporting requirements and discusses how to prepare for what is poised to be one of the most significant changes to the partnership compliance function in decades.
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