The IRS continues to fine-tune its international tax reporting framework for pass-through entities through ongoing changes to Schedules K-2 and K-3, which accompany Forms 1065 (partnerships) and 1120-S (S corporations). These schedules are designed to provide greater transparency into international tax attributes such as foreign income, taxes paid or accrued, foreign tax credits, and activities that may affect partners or shareholders with international tax obligations.
For the 2025 tax year, the IRS has introduced key updates that aim to reduce compliance burdens on small entities and streamline filing when only portions of K-3 are requested. Specifically, new relief provisions now exempt qualifying small entities from filing these schedules entirely under certain conditions, and the process for responding to partial requests from partners/shareholders has also been made more flexible.
This blog will explain in detail what Schedules K-2 and K-3 are, who needs to file them, what’s changed in 2025, and how these updates benefit small partnerships and S corporations navigating U.S. international tax reporting obligations.
What Are Schedules K-2 and K-3?
Schedules K-2 and K-3 were introduced as part of the IRS’s effort to standardize and expand reporting of foreign tax information from pass-through entities to their partners or shareholders. These schedules replace and expand upon the former line items on Schedule K and Schedule K-1 that dealt with foreign income, deductions, and credits.
- Schedule K-2: An extension of Schedule K, used to report the entity’s international tax-related information.
- Schedule K-3: Similar to Schedule K-1, it provides each partner or shareholder with their share of the international tax information reported on Schedule K-2.
These forms became mandatory for partnerships and S corporations with international activities or foreign partners/shareholders, even if minimal. Compliance had initially been burdensome, especially for smaller entities with limited or no foreign involvement.
2025 Update: Small-Entity Exception Expansion
For the 2025 tax year, the IRS has formally expanded the domestic small-entity exception for Schedules K-2 and K-3. The intention is to reduce the compliance burden for entities that have no meaningful foreign activity and whose partners/shareholders do not require international tax data.
Eligibility Criteria for the Exception
Entities may now qualify for the exception if all the following conditions are met:
- All partners or shareholders are U.S. persons (citizens or resident aliens, or domestic entities).
- The entity has no foreign income, no assets generating foreign-source income, and does not claim a foreign tax credit.
- No partner or shareholder has requested Schedule K-3 information for the current tax year by the later of the filing deadline (including extensions) or one month before the return is filed.
- The entity informs partners/shareholders in a timely manner that no Schedule K-3 will be provided unless requested.
These conditions mirror and expand on relief previously provided by the IRS through FAQ guidance and temporary transition relief in prior years.
Communication Requirement
One of the most critical aspects of this relief is the requirement to proactively notify partners/shareholders about the availability of Schedule K-3 data. Entities must notify their stakeholders before the Schedule K-3 delivery deadline (typically the due date for Schedules K-1).
Notification can be done through any of the following:
- Email or electronic portal communication
- A general partner/shareholder letter included with Schedule K-1
- Instructions provided during onboarding or subscription agreements
Partial K-3 Requests: New Flexibility for Filing
In 2025, the IRS has also introduced more flexibility in handling situations where only specific parts of Schedule K-3 are requested by one or more partners or shareholders.
Previously, receiving a request from a single stakeholder could trigger the requirement to file the entire Schedule K-2/K-3 package with the IRS and deliver it to all partners or shareholders. The new rules reduce this burden by allowing entities to:
- Only complete and file the sections of Schedules K-2 and K-3 relevant to the request
- Exclude all other unrelated parts (e.g., if only Section 1 regarding foreign tax credit is needed)
- Deliver only the applicable sections to the requesting partner/shareholder
This streamlined process is particularly helpful for entities with minimal international activities that may only occasionally have a partner needing information for Form 1116 (Foreign Tax Credit).
IRS Filing Requirements Under the New Guidance
Under the 2025 updates, here’s how the filing decision tree now looks:
- No foreign activity + all U.S. partners + no requests = No K-2/K-3 required
- No foreign activity + all U.S. partners + partial request = File partial K-2/K-3
- Foreign activity = File full K-2/K-3 for all partners/shareholders
The IRS will continue to monitor the use of these exceptions and may update guidance in future years. Entities claiming the exception must maintain adequate documentation to demonstrate eligibility in the event of an audit.
Impact on Forms 1065 and 1120-S Filing
These changes have a direct impact on how pass-through entities complete their federal returns:
- Form 1065 filers must decide by the return due date whether a K-2/K-3 is necessary
- S corporation filers using Form 1120-S must follow similar procedures, even if shareholders are all domestic individuals
- Failure to provide Schedule K-3 when requested or required can result in penalties under IRC §6698 and §6722
Entities should update their compliance workflows to include early-season assessments of partner/shareholder residency and communication strategies.
Best Practices for 2025 Compliance
- Document the citizenship/residency status of all partners or shareholders
- Communicate with stakeholders about K-3 availability and request deadlines
- Use software or a tax professional to generate only applicable K-2/K-3 sections when partial requests arise
- Maintain written documentation of treaty benefits, foreign income, or foreign tax credit activity
- Monitor the IRS website and FAQs for further updates or clarifications
Conclusion
The 2025 updates to Schedules K-2 and K-3 filing requirements offer welcome relief to small partnerships and S corporations that have no international tax obligations and limited partner needs. By expanding the small-entity exception and allowing partial filing in response to partner requests, the IRS is easing compliance while maintaining transparency for those with genuine foreign tax reporting obligations.
Pass-through entities should familiarize themselves with these new provisions and take proactive steps early in the tax year to determine eligibility, communicate with stakeholders, and streamline their filing processes. With proper planning and documentation, businesses can reduce compliance costs while maintaining full adherence to IRS requirements for international tax disclosures.
