2022-51: Schedule K-2/K-3 domestic partnership exemption expanded and revised

(UPDATE, 12/7/22: The original version of this posting incorrectly stated that the S corporation draft instructions were not revised. However, the revised Schedule K-2/K-3 (1120-S) instructions did delete the January 15 notification requirement and state that, similar to the revised partnership notification requirements, S corporations need only provide notification to their shareholders that they can request a copy of Schedule K-3 when Schedule K-1 is issued.)

In the latest draft of the Schedule K-2/K-3 (1065) instructions released on December 2, 2022, the IRS has expanded eligibility for the new domestic partnership exemption from filing Schedules K-2 and K-3 and revised the partnership notification requirements for partnerships that want to qualify for the exemption.

As before, to qualify for the domestic partnership exemption, the partnership must have no or only limited foreign activity and all of its partners must be individuals who are U.S. citizens or resident aliens, domestic decedent estates, or domestic grantor trusts. However, in the latest draft instructions, eligible partnerships now also include those partnerships with partners that are S corporations owned by a sole shareholder and disregarded single-member LLCs owned by U.S. citizens or resident aliens, domestic decedent estates, domestic grantor trusts, or sole shareholder S corporations.

Also, to qualify for the exemption, a partnership is no longer required to send a notice to the partners informing them that they may request Schedule K-3 by two months before the original due date of the partnership’s return without regard to extensions (January 15 for calendar-year partnerships).

Rather, qualifying partnerships can simply notify their partners that they can request Schedule K-3 at the time the partnership sends Schedule K-1 to the partner. The notice can even be sent as an attachment to Schedule K-1. However, the partner can request the partnership to provide Schedule K-3 up to one month before the extended due date of the partnership return (August 15 for calendar-year partnerships). Similar revisions were made to the December 2, 2022, K-2/K-3 (1120-S) revised instructions.

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