Are You Ready To Climb K-2 and K-3?

Just when you thought international tax compliance couldn’t get any harder or more convoluted, new developments out of Washington threaten to make a complicated area even more difficult. On July 14, 2020, the Treasury Department and Internal Revenue Service released a proposed redesigned partnership form for the tax year 2021 (i.e. for the 2022 filing season). The proposed form is intended to provide partners with more clarity with respect to international tax items, specifically regarding claiming deductions and credits in computing their U.S. income tax liability. The key word in the previous sentence is “intended” because, in actuality, the additional compliance burden being foisted upon U.S. partnerships with international activity is potentially mountainous.

Who could this impact? Two sectors to focus on would be the theatre and entertainment industry with productions going overseas and financial services with investment vehicles in the U.S. partnerships structure.

Historically, partners in partnerships with international operations or investments were provided information through K-1 footnote disclosures. While those statements often came in various formats and posed some technical challenges for taxpayers and their tax preparers to properly translate into returns, it allowed a partnership some flexibility in how it transmitted information to its partners. While the proposed changes are intended to streamline this process by providing a standard format for information to be transmitted, it seems the IRS has made things far more complicated by introducing two new multi-page schedules.

This added complexity places significant burden on the partnerships to comply with these new forms and may cause, in some cases, impede partnership business operations.

New Schedules in Proposed Partnership Form:

If a partnership has no international operations and no international investments, these new Schedules are not required.

Is the New Partnership Form and Schedule K-2 and K-3 Finalized?

The news is not all bad, however. The analogy to mountain climbing is apropos given that one doesn’t just attempt to climb a mountain without years of preparation. Similarly, the IRS has released these forms now, well in advance of their intended use, in order to give stakeholders ample time to review and comment upon the schedules and their instructions. It is possible that the IRS will implement feedback from the tax practitioner community and reduce the complexities of these new forms or perhaps eliminate the proposed Schedule K-2 and K-3 altogether.

In the meantime, stay tuned for further updates as the Schedules in current proposed form are likely to change between now and when they are finalized.

How Would the Proposed Redesigned Partnership Form Impact the Theatre and Entertainment Industry?

In recent years many successful productions originally produced in the U.S. have gone overseas to London’s West End and beyond. And likewise many successful productions being produced outside of the U.S. are done through full or partial funding from U.S. investors. Commonly these productions investment structure includes a U.S. partnership. These U.S. partnerships would be required to file these forms K-2 & K-3 as part of the Form K-1 package they currently prepare for their investors. This additional filing requirement would add complexity to a reporting system that is already more complicated than seems necessary.

How Would the Partnership Form Impact the Financial Services Industry?

Many investment vehicles in the financial services industry including private equity, hedge funds, SPACS and more are in a U.S. partnership structure. These funds always race to provide their investors with K-1s by the end of March each year. This added filing requirement will add stress to an already intense process of timely getting K-1 packages out to investors.

Author: Josh Gelernter | [email protected]