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IRS Adds New Domestic Filing Exception for Partnership Schedules K-2 and K-3
Beginning with their 2021 tax years, partnerships with “items of international tax relevance” must file Schedule K-2, Partners’ Distributive Share Items—International, and Schedule K-3, Partner’s Share of Income, Deductions, Credits, etc.—International.
Draft partnership instructions for the 2022 Schedules K-2 and K-3 (Form 1065) and partner’s instructions for the 2022 Schedule K-3 were released October 25. The instructions add a “domestic filing exception” for a partnership that meets all four of the following requirements for its 2022 tax year:
- The partnership has:
- no foreign activity, defined as foreign income taxes paid or accrued, foreign source income or loss, or an ownership interest in a foreign partnership, corporation, foreign branch, or foreign disregarded entity, or
- foreign activity that is limited to passive category foreign income generating no more than $300 of taxes subject to the foreign tax credit (and shown on a payee statement);
- All of the partners are U.S. citizens or resident aliens, domestic decedent’s estates with only U.S.-citizen or resident-alien beneficiaries, domestic grantor trusts with only U.S.-citizen or resident-alien grantors and beneficiaries, or domestic non-grantor trusts with only U.S.-citizen resident-alien beneficiaries;
- The partners receive a notification from the partnership electronically or by mail, dated no later than two months before the due date of the partnership’s return, that the partners will not receive Schedules K-3 unless they request them; and
- The partnership does not receive a request from any partner for Schedule K-3 at least one month before the due date of the return (that is, a calendar-year partnership does not receive any requests by February 15, 2023).
A partnership that receives a timely request from a partner for a Schedule K-3 does not qualify for the domestic filing exception and must file Schedules K-2 and K-3 with the IRS and provide Schedule K-3 to the requesting partner. However, the partnership only needs to complete the parts of Schedules K-2 and K-3 that are relevant to that partner.
If a partnership receives a request from a partner for a Schedule K-3 after the one-month date but no requests by that due date, the partnership only needs to provide Schedule K-3 to the requesting partner by the date on which the partnership files its return or one month after it receives the request, whichever is later.
The draft instructions note that if a partnership fails the domestic filing exception test, it may still qualify for an exception to the filing requirement if all of its partners are eligible for the exemption from filing Form 1116.
A regularly updated IRS FAQ sheet on Schedules K-2 and K-3 states that “comments on the draft instructions can be provided to [email protected] on or before November 8, 2022.”
The draft instructions also add guidance on when a domestic partnership with only domestic activity needs to file Schedules K-2 and K-3, on reporting capital gains and losses and foreign tax redeterminations, and on reporting income inclusions required by 2022 regulations that apply aggregate treatment to domestic partnerships in some situations.
Draft instructions for S corporations’ 2022 Schedules K-2 and K-3 have not been issued yet.
Tax Gap Reaches Nearly $500 Billion, IRS Reports
The Internal Revenue Service is estimating the tax gap on tax years 2014-2016 to be $496 billion, an increase of more than $58 billion from the prior estimate.
“The increase in the tax gap estimates reflects that the IRS needs to do more, both in improving taxpayer service as well as working to improve tax compliance,” IRS Commissioner Charles Rettig said in a statement, adding that the recent funding in the Inflation Reduction Act “will help the IRS in many ways, increasing taxpayer education, significantly improving services to all taxpayers and focusing on high-income/high-wealth non-compliance in a fair and impartial manner supporting compliant taxpayers.”
IRS published a report on the new estimate on October 28, 2022.
According to the report, the estimated net compliance rate is 87 percent, defined as tax paid voluntarily and timely plus enforced and other late payments divided by the total true tax. The voluntary compliance rate, which is the amount of tax paid voluntarily and timely divided by the total true tax is estimated to be 85.0 percent.
The tax gap includes three components, including:
- nonfiling (tax not paid on time by those who do not file on time) – $39 billion;
- underreporting (tax understated on timely filed returns) – $398 billion; and
- underpayment (tax that was reported on time, but not paid on time) – $59 billion.
The report estimates that $68 billion of the tax gap will eventually be paid.
The IRS also reported that the tax gap for years 2017-2019 is projected to increase to $540 billion.
Social Security Wage Cap and Benefit Amounts Increase for 2023, Social Security Fact Sheet: 2023 Social Security Changes
For 2023, the Social Security wage cap will be $160,200, and social security and Supplemental Security Income (SSI) benefits will increase by 8.7 percent. These changes reflect cost-of-living adjustments to account for inflation.
Wage Cap for Social Security Tax
The Federal Insurance Contributions Act (FICA) tax on wages is 7.65 percent each for the employee and the employer. FICA tax has two components:
- a 6.2 percent social security tax, also known as old age, survivors, and disability insurance (OASDI); and
- a 1.45 percent Medicare tax, also known as hospital insurance (HI).
For self-employed workers, the Self-Employment tax is 15.3 percent, consisting of:
- a 12.4 percent OASDI tax; and
- a 2.9 percent Medicare tax.
OASDI tax applies only up to a wage base, which includes most wages and self-employment income up to the annual wage cap.
For 2023, the wage base is $160,200. Thus, OASDI tax applies only to the taxpayer’s first $160,200 in wages or net earnings from self-employment. Taxpayers do not pay any OASDI tax on earnings that exceed $160,200.
There is no wage cap for Medicare tax.
Maximum Social Security Tax for 2023
For workers who earn $160,200 or more in 2023:
- an employee will pay a total of $9,932.40 in social security tax ($160,200 x 6.2 percent);
- the employer will pay the same amount; and
- a self-employed worker will pay a total of $19,864.80 in social security tax ($160,200 x 12.4 percent).
Additional Medicare Tax
Higher-income workers may have to pay an Additional Medicare tax of 0.9 percent. This tax applies to wages and self-employment income that exceed:
- $250,000 for married taxpayers who file a joint return;
- $125,000 for married taxpayers who file separate returns; and
- $200,000 for other taxpayers.
The annual wage cap does not affect the Additional Medicare tax.
Benefit Increase for 2023
A cost-of-living adjustment (COLA) will increase social security and SSI benefits for 2023 by 8.7 percent. The COLA is intended to ensure that inflation does not erode the purchasing power of these benefits.