March 4, 2022
Tax forms change all the time. Tax laws change all the time. In most years the changes pass unnoticed except by preparers, or those reviewing tax returns.
Not so this year. Two new forms introduced by the IRS for 2021 partnership and S corporation filings triggered a tax preparer rebellion that forced the IRS to publicly relent on the filing requirement for 2021 for some taxpayers. Still, some preparers aren't satisfied, and others are not sure what to file from here. As the penalties for not filing correctly can be severe, the answers matter.
The forms at issue are forms K-2 and K-3, which gather and sort information for partners and S corporation shareholders to properly report foreign tax items on their own returns. The K-2, which gathers the information for the entity, runs to 19 pages. The K-3, which is the report of these items for shareholders, is 20 pages long.
The IRS issued the form in draft last fall. To the extent they noticed the form at all, practitioners assumed it would only apply where the taxpayer had foreign activities. In January the IRS clarified that it applied to all partnerships (it was less clear for S corporations) unless the partnership had "actual" knowledge that partners didn't need the information. Tax practitioners rebelled.
The IRS was taken by surprise. From a strictly-technical viewpoint, the surprise is almost understandable. As scary as the new forms are, they require most filers to only gather a few numbers:
- Gross receipts.
- Deductions sorted by category (attributable to sales, services, rental, etc).
- Interest expense, sorted by category.
- Tax basis of assets at the beginning and end of the year.
Taxpayers with research expense also need to identify the business class the expenses relate to. While gathering these numbers is extra work, it's information that preparers generally have, even if they haven't had to dig it out and put it in the format the IRS wants.
But context matters. This filing season was shaping up to be difficult already. It was obvious that the IRS is broken, given how many clients still are waiting on 2020 refunds, are getting notices for returns they have filed, or are getting threatened with levies arising from erroneous notices that practitioners had responded to months ago. Tax pros have also been hit by the "great resignation" and find themselves having to handle more complex work with reduced staffing. They were cranky. The K-2/K-3 forms were a spark hitting gasoline-soaked tinder. Whatever merit the new forms have, the timing was atrocious.
The new forms do serve a real need. The old K-1 forms did a poor job reporting foreign information. Instead, the K-1s would come with pages of confusing footnote disclosures that were easily ignored, often to the partners' detriment.
I hope the IRS starts over and simplifies the forms for next year. It would be a good start to break out the few items purely-domestic partnerships need to disclose on their own form, or on the K-1 itself. The K-2/K-3 forms could then be reserved for partnerships that really do have international issues. An extra grace period for compliance and an exclusion or simplified versions for small U.S. - only filers would also help. An IRS that could handle the information they already have would help even more.
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