2Schedules K-2 and K-3 have been introduced for the tax year 2021. These schedules serve as replacements, supplements, and clarifications for the previous Form 1065, specifically Line 16, which pertained to Partners' Distributive Share Items and Foreign Transactions. The subsequent section will describe in detail the related schedules K-2 and K-3.

1. What is Schedules K-2 and K-3?
   
   Schedule K-2 serves as an extension of Schedule K, which is included in both Form 1065 and is utilized for the purpose of disclosing pertinent international tax information derived from the activities of a partnership.
   
   On the other hand, Schedule K-3 serves as an extension of Schedule K-1 and provides partners with a detailed breakdown of their respective portions of the items listed on Schedule K-2.
   
   The forms comprise distinct Schedules K-2 and K-3 designed for partnerships that are submitting Form 1065, U.S. Return of Partnership Income, S corporations that are submitting Form 1120-S, U.S. Income Tax Return for an S corporation, and U.S. individuals who are submitting Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships.
   
   In order to account for the varying stability and operational needs of entities established in different countries, the Internal Revenue Service (IRS) mandates the provision of specific information regarding the countries in which the entity operates. Previously, it was permissible to indicate "Various" as the country location, but with the introduction of Schedules K-2 and K-3, it is now necessary to list each country separately.
   
   
2. Who must file Schedules K-2 and K-3?
   
   Partnerships that are obligated to submit Form 1065 and possess information pertinent to the assessment of U.S. tax or specific withholding tax or reporting responsibilities of their partners in accordance with the international provisions of the Internal Revenue Code are required to fulfill the applicable sections of Schedules K-2 and K-3.
   
   For instance, even if a partnership does not have any income from foreign sources, assets generating foreign source income, or foreign taxes paid or accrued, it may still be necessary to disclose information on Schedules K-2 and K-3. This is because the sourcing information of income and deductions may be pertinent for partners who are seeking to claim a foreign tax credit.
   
   If Form 1065 is submitted without the necessary information or if Schedules K-3 are provided to partners without the requisite information, there may be penalties imposed.
   
   
3. New exception from completing Schedules K-2 and K-3
   
   Starting from the tax year 2022, If all four of the following conditions are satisfied in relation to the domestic partnership, an exception from filing Schedules K-2 and K-3 is applicable.
   
   

   (1)	There is no or limited foreign activity (defined as passive category foreign income generating no more than $300 of foreign income taxes eligible for the foreign tax credit).
   (2)	All the partners or shareholders are U.S. citizens or resident aliens.
   (3)	Partnership or S corporation sends notification of intent to not file Schedules K-2/K-3 with the timely issuing of Schedule K-1. And no partners or shareholders request a Schedule K-3.
   (4)	The partnership does not receive any requests from its partners for Schedule K-3 information by the specified deadline, which is one month prior to the filing date of Form 1065. In the case of calendar year partnerships for the tax year 2022, the latest deadline is August 15, 2023, if the partnership has filed for an extension.

   
   If the partnership receives a request from a partner for Schedule K-3 information within one month, and as a result does not meet criterion 4, the partnership must submit Schedules K-2 and K-3 to the IRS and provide the Schedule K-3 to the partner making the request. The completion of Schedules K-2 and K-3 is necessary only for the parts and sections that pertain to the requesting partner.
   
   If a partnership receives a request from a partner for the Schedule K-3 information beyond the one-month deadline, the partnership is exempted from the obligation to submit the tax year 2022 Schedules K-2 and K-3 to the IRS or provide the tax year 2022 Schedule K-3 to the partners who did not make the request.
   However, the partnership is obligated to furnish the requesting partner with the tax year 2022 Schedule K-3, containing the necessary information, either on the date the partnership submits Form 1065 or within one month of receiving the partner's request.
   
   
4. Qualification for Schedule K-2/K-3 filing relief
   
   

   (1)

   In the context of tax reporting, it is not necessary for a domestic partnership to fill out Schedule K-2 and K-3 if all partners meet the requirements for the Form 1116 exemption and the partnership is informed of a partner's eligibility for this exemption prior to the one-month deadline. If a partnership is informed by only a portion of its partners that they are eligible for the Form 1116 exemption, the partnership is not required to fill out Schedule K-3 for those exempt partners. However, the partnership must still complete Schedules K-2 and K-3 for the remaining partners, to the extent that the partnership does not meet the criteria for the domestic filing exception.

   (2)

   Additionally, partnerships that do not engage in any foreign activity and have limited partners with ownership stakes below 10% will also qualify for filing relief for specific sections of Schedules K-2 and K-3.

Reference:
https://www.irs.gov/forms-pubs/changes-to-the-2021-partnership-instructions-for-schedules-k-2-and-k-3-form-1065
https://www.irs.gov/businesses/schedules-k-2-and-k-3-frequently-asked-questions-forms-1065-1120s-and-8865).
https://www.irs.gov/newsroom/irs-issues-a-frequently-asked-question-for-pass-through-entities-to-report-negative-amounts-to-the-irs-on-part-ii-of-schedules-k-2-and-k-3