Schedules K-2 and K-3 Frequently Asked Questions (Forms 1065, 1120S, and 8865)

 
  • The 2021 Form 1065 Schedule K-2 reports items of international tax relevance and is an extension of the Form 1065, Schedule K.  It replaces line 16a-r, portions of line 20, and numerous unformatted statements attached to prior versions of the Schedule K.  In general, the Form 1065 Schedule K-3 reports a partner’s distributive share of items of international tax relevance and is an extension of the Form 1065 Schedule K-1.  It replaces line 16, portions of line 20, and numerous unformatted statements attached to prior versions of the Schedule K-1 Form 1065, Schedule K-1.  In tax years beginning in 2021, flow-through entities with items of international tax relevance must complete the new schedules, as described in the instructions and the updates posted on January 18, 2022.  See FAQ #17 for links.  International tax relevance is determined under each part of the new schedules.  Similar revisions apply for the Forms 1120-S and 8865.
  • The new schedules K-2 and K-3 were created to provide consistency in the reporting to partners and shareholders.  Prior versions of schedules K and K-1 did not require any specific format to provide international information, resulting in what could be a confusing array of statements attached to the schedules K and K-1.  The new schedules K-2 and K-3 provide greater certainty and consistency, helping partners and shareholders to voluntarily comply with their filing and reporting obligations.  The greater certainty also enables the IRS to verify that partnership and S corporation items are properly reported on partners’ and shareholders’ returns.  This should reduce the burden on both taxpayers and the IRS by reducing unnecessary inquiries and examinations that may arise due to inconsistent reporting of partnership and S corporation items.
  • The new schedules accommodate the complex Tax Cuts and Jobs Act (TCJA) (international provisions enacted in 2017).  TCJA required a significant increase in the amount and types of information needed to calculate the U.S. tax liability with respect to items of international tax relevance.  The TCJA has largely been implemented in several forms, such as the Forms 1040 and 1120 and associated schedules.  Having worked through those other changes, the IRS is now making similar changes to flow-through returns to ensure that investors, the ultimate taxpayers in the case of flow-through entities, have the information to accurately complete their returns.  The IRS observed in the years following TCJA that items of international tax relevance were not always reported in a clear and standard format on Schedules K and K-1 attachments.  Having clear and consistent forms and instructions will ultimately help partnerships and S corporations report in an efficient manner.
  • Having consistent and standardized forms and instructions will help partners and partnerships and shareholders and S corporations to comply with the various complex international tax rules in an efficient manner.
  • While partnerships and S corporations will initially have transition costs, ultimately they will benefit from increased transparency of information, and reduced uncertainty about what to report and how to report it. 
  • Partnerships and S corporations may not have previously reported information in as much detail and for every fact pattern where reporting is required.  The new schedules require more detailed and more complete reporting than partnerships and S corporations may have been providing previously to partners and shareholders, which is necessary for partners and shareholders to accurately complete their own returns.  See FAQ #11 and FAQ #12
  • For the content of the schedules, the IRS relies on provisions of the Internal Revenue Code and regulations thereunder that define a partnership’s and partners’ obligations in determining their tax liability.  For the authority to create and require these schedules, the IRS relies on Treasury Regulation section 1.6031(a)-1(a)(1) and (2), which generally provides that every domestic partnership must file a return of partnership income under section 6031 (partnership return) for each taxable year on the form prescribed for the partnership return. The partnership return must contain the information required by the prescribed form and the accompanying instructions.
  • Yes, these schedules are currently available to be electronically submitted.  However, Modernized e-File (MeF)/Extensible Markup Language (XML) electronic filing capability for the schedules K-2 and K-3 for tax year 2021 will not be available as of the beginning of the 2022 filing season (January 2022).  The timeline for the MeF/XML filing capability is provided below. The MeF/XML filing capability for the Form 1065 was available starting on March 20, 2022.    If you electronically file your return before the time frames, submit the schedules as separate PDF files attached to the return.   Taxpayers will also be able to file their Schedules K-2 and K-3 via PDF attachments for the entire 2022 filing season.
 
Form Number Date Available
Form 1065, Schedules K-2 and K-3 March 20, 2022
Form 1120-S, Schedules K-2 and K-3  July 24, 2022
Form 8865, Schedules K-2 and K-3 January 2023

 

  • If you electronically file your return before the time frames as listed above in FAQ #7, submit the schedules as separate PDF files attached to the return.  Taxpayers will also be able to file their Schedules K-2 and K-3 via PDF attachments for the entire 2022 filing season.​​​​
  • The IRS worked diligently to get the new schedules available for filing season 2022.  Resource and technical limitations prevented the IRS from implementing XML before the above-mentioned time frames as listed in FAQ #7.  The IRS believes that the benefit of standardized reporting in this area for partners, shareholders and the IRS outweighs the delay in obtaining information in XML format.
  • Taxpayers who make a good faith effort to comply with the new schedules for tax year 2021 will not be assessed a penalty, as described in IRS Notice 2021-39PDF. According to the Notice, a filer will not be subject to penalties if it made a good faith effort to determine whether it must file a part and how to complete a part if it determines it must file.  The notice outlines some factors the IRS will take into account in determining if a partnership or S corporation made a good faith effort.
  • In many instances, a partnership or S corporation with no foreign partners, foreign source income, no assets generating foreign source income, and no foreign taxes paid or accrued may still need to report information on Schedules K-2 and K-3.  For example, if the partner or shareholder claims the foreign tax credit, the partner generally needs certain information from the partnership on Schedule K-3, Parts II and III, to complete Form 1116.  This information should have been reported in prior years, including before the Tax Cuts and Jobs Act, on the Schedules K and K-1, and is information the partner or shareholder needs to compute the foreign tax credit limitation, which determines the amount of foreign tax credit available to the partner or shareholder.
  • This information was requested in the June 2021 instructions which stated, “this requirement [to complete Parts II and III] applies regardless of whether the partnership pays or accrues foreign taxes because other information, such as the source of the partnership’s income and the value of its assets, are relevant in determining the partner’s foreign tax credit.”  See page 7, first column of the instructionsPDF.
  • Section 904 generally limits the foreign tax credit to the taxpayer’s U.S. tax rate multiplied by its foreign source taxable income.  Foreign source taxable income is foreign source gross income less allocable expenses.  In general, the partnership or S corporation must complete the Schedules K-2 and K-3, Parts II and III because the source of certain gross income is determined by the partner or shareholder.  In addition, some expenses of the partnership or S corporation are allocated and apportioned by the partner or shareholder.  Because of this partner- or shareholder-level determination, it is not possible for the partner or shareholder to assume that all income of the partnership or S corporation is U.S. source and all expenses of the partnership or S corporation reduce U.S. source income.  Also, the allocation and apportionment of certain partner- or shareholder-level expense take into account distributive shares of assets and income of the partnership and S corporation that are not otherwise reported on the Schedule K-1.
    • For example, for sourcing purposes, personal property sold by the partnership is treated as sold by the partners.  See section 865(i)(5).  Generally, income from the sale of certain personal property (excludes inventory) is sourced according to the residence of the seller.  In cases in which the partner is a pass-through entity, the partnership will not know the ultimate residence of the seller partner.  The partnership’s or S corporation’s gain on the sale of personal property is not separately stated on Schedules K and K-1, but is reported on Schedules K-2 and K-3, Part II. 
    • As another example, the partner’s research and experimental (“R&E”) expense (which includes the distributive share of the partnership’s R&E expense) is allocated and apportioned by the partner or shareholder.  Section 1.861-17(f).  R&E expense is allocated and apportioned based on the gross receipts by SIC code.  R&E expense by SIC code is not reported on Schedules K and K-1, but is reported on Schedules K-2 and K-3, Part II.  Also, the partner or shareholder needs Schedule K-3, Part III, Section 1 for the partner’s or shareholder’s share of the partnership’s or S corporation’s gross receipts by SIC code for purposes of allocating and apportioning R&E expense. 
    • In some cases, the partner or shareholder will be able to use the information reported on Parts II and III to increase the foreign tax credit limitation, and the amount of available foreign tax credit to the partner or shareholder.  For example, Part II, Section 2 and Part III, Section 2 provides the partner or shareholder with the interest expense and tax book value of the assets of the partnership or S corporation, respectively.  In general, a partner or shareholder apportions interest expense to reduce U.S. source gross income or foreign source gross income based on the tax book value of its assets, including its distributive share of the partnership’s or S corporation’s interest expense and assets.  Sections 864(e)(2) and 1.861-9(e).  Taking into account the assets of a domestic partnership or S corporation generating solely U.S. source income would result in more expense allocated to U.S. source gross income and less expense allocated to reduce foreign source gross income.  Having more foreign source income increases the partner’s or shareholder’s foreign tax credit limitation, and the ability of the partner or shareholder to claim foreign tax credits.  The regulations provide exceptions to certain rules for the asset method of apportionment for less-than-10% limited partners, and the instructions take this into account by excepting the partnership from completing certain portions of the Schedules K-2 and K-3 with respect to these partners.  Schedules K and K-1 do not report the partnership’s or S corporation’s interest expense, or the tax book value of the assets as required by section 1.861-9(e).  See the instructions to Schedules K-2 and K-3 for further guidance.
    • If the domestic partnership with no foreign activity or foreign partners has direct or indirect domestic corporate partners, Part IV (Foreign-derived intangible income), and Part IX (base erosion anti-abuse tax).  Further, if a domestic partnership has an indirect partner that is a foreign partner, Part X (effectively connected income), and Part XIII (section 864(c)(8)) may also need to be completed.  See the instructions to Schedules K-2 and K-3 for further guidance.
  • Example #1
    • U.S. citizen A and U.S. citizen B own equal interests in domestic partnership, which uses a calendar taxable year.  In Year 1, domestic partnership has no foreign source income and no assets that generate foreign source income.  Domestic partnership does not pay or accrue foreign taxes.  In Year 1, A pays $2,000 of foreign income taxes on passive category income other than capital gains which was reported to A on a qualified payee statement.  A does not pay or accrue any other foreign taxes and has no other foreign source income.  B does not pay or accrue foreign income taxes.  In Year 1, because B paid no foreign taxes for which it can claim a foreign tax credit, and such information was provided to domestic partnership by B, with respect to B, domestic partnership need not complete Schedule K-3. 
    • Because A must complete Form 1116 to claim a foreign tax credit, domestic partnership must complete the relevant portions of Parts II and III of Schedules K-2 and K-3 (for A).  The tax book value of domestic partnership’s assets is $100,000 and A’s share of those assets is $50,000.  Not including its distributive share of the assets of domestic partnership, the tax book value of A’s assets is $50,000.  Of A’s assets, $10,000 generate foreign source income and $40,000 generate U.S. source income.  A has interest expense of $5,000 and domestic partnership does not have interest expense.  A has passive category foreign source taxable income before interest expense of $8,000.  A’s U.S. effective tax rate is 25%. 
    • A’s interest expense is apportioned between U.S. source and foreign source income ratably based on the tax book value of A’s U.S. source and foreign source assets.  Without taking into account the distributive share of domestic partnership assets, the amount of A’s interest expense that would reduce foreign source gross income is $1,000 ($5,000 x $10,000 / $50,000).  Therefore, A’s foreign source taxable income would be $7,000 ($8,000 - $1,000).  At a 25% U.S. tax rate, A may only use $1,750 (25% x $7,000) of the $2,000 of foreign taxes in Year 1 pursuant to section 904(d). 
    • Taking into account the distributive share of domestic partnership assets, the amount of A’s interest expense that reduces foreign source gross income is $500 ($5,000 x $10,000 / $100,000).  Therefore, A’s foreign source taxable income would be $7,500 ($8,000 - $500).  At a 25% U.S. tax rate, A may use $1,875 (25% x $7,500) of the $2,000 of foreign taxes in Year 1 -- an additional foreign tax credit amount of $125 after taking into account A’s share of the tax book value of the partnership assets. 
    • Similar rules apply with respect to S corporations.
  • Example #2
    • U.S. citizen A and U.S. citizen B own equal interests in domestic partnership, which uses a calendar taxable year.  In Year 1, domestic partnership has no foreign source income and no assets that generate foreign source income.  Domestic partnership does not pay or accrue foreign taxes.  In Year 1, A pays $2,000 of foreign income taxes on passive category income other than capital gains which was reported to A on a qualified payee statement.  A does not pay or accrue any other foreign taxes and has no other foreign source income.  B does not pay or accrue foreign income taxes.  In Year 1, because B paid no foreign taxes for which it can claim a foreign tax credit and such information was provided to domestic partnership by B, domestic partnership need not complete Schedule K-3 for B. 
    • Because A must complete Form 1116 to claim a foreign tax credit, domestic partnership must complete the relevant portions of Parts II and III of Schedules K-2 and K-3 (for A).  Neither A nor domestic partnership have interest expense or R&E expense.  Therefore, domestic partnership need not complete Part III.  Domestic partnership does not have any gross income the source of which is determined by the partner.  A has $5,000 of expenses described in section 1.861-8(e)(9) which must be ratably apportioned based on A’s gross income (including its distributive share of the income of domestic partnership).  See section 1.861-8(c)(3).  Therefore, domestic partnership must complete Schedule K-2, Part II and Schedule K-3, Part II (for A).  Both A and domestic partnership have no other expenses.
    • A’s share of domestic partnership’s gross income (before expenses) is $50,000.  Not including its distributive share of the income of domestic partnership, A’s gross income (before expense) is $50,000.  Of A’s gross income, $5,000 is foreign source gross income and $45,000 is U.S. source gross income.  A’s U.S. effective tax rate is 25%. 
    • Before taking into account the distributive share of domestic partnership gross income, the amount of A’s expenses described in section 1.861-8(e)(9) that reduce foreign source gross income is $500 ($5,000 x $5,000 / $50,000).  Therefore, A’s foreign source taxable income would be $4,500 ($5,000 - $500).  At a 25% U.S. tax rate, A may only use $1,125 (25% x $4,500) of the $2,000 of foreign taxes in Year 1 pursuant to section 904(d). 
    • Taking into account the distributive share of domestic partnership gross income, the amount of A’s expenses described in section 1.861-8(e)(9) that reduce foreign source gross income is $250 ($5,000 x $5,000 / $100,000).  Therefore, A’s foreign source taxable income would be $4,750 ($5,000 - $250).  At a 25% U.S. tax rate, A may use $1,187.50 (25% x $4,750) of the $2,000 of foreign taxes in Year 1 -- an additional foreign tax credit amount of $62.50 after taking into account A’s distributive share of the gross income of domestic partnership. 
    • Similar rules apply with respect to S corporations.
    • Note. A partner or shareholder of an S corporation may need the distributive share of the partnership’s gross income for purposes of allocating and apportioning expenses other than those described in section 1.861-8(e)(9). 
  • The January 18 updates provided clarification and exceptions to completing the Schedules K-2 and K-3. 
  • The updates clarify the prior instructions in response to public comments on reporting of personal property sales, as well as distributions and income inclusions with respect to foreign corporations. Compared to some interpretations of the prior instructions, the clarifications reduce potential reporting on these items.
  • The changes generally clarify that domestic partnerships that have solely domestic activities, and have less-than-10% limited U.S. citizen and U.S. resident individual partners are excepted from filing certain portions of Schedules K-2 and K-3.
  • The updates reduce the requirement to attach certain forms to Schedule K-3.
  • The instructions and the January 18, 2022 updates provide certain exceptions to completing Schedules K-2 and K-3.  For example:
  • As stated in the instructions, the partnership need not complete Schedules K-2 and K-3, Parts II and III if it knows that it has no direct or indirect partners eligible to claim a foreign tax credit.  A similar exception applies with respect to S corporations.
  • Additionally, the instructions provide that, if a direct or indirect partner is eligible to claim a foreign tax credit, the partnership does not need to complete the Schedules K-2 and K-3, Parts II and III, if the partnership knows that the direct and indirect partners are not completing Form 1116 or 1118.  This could be the case, for example, when the partnership knows that the direct and indirect partners do not claim a foreign tax credit or when the partnership knows that the direct and indirect partners qualify for an exception to filing the Form 1116 or Form 1118.  See Foreign Tax Credit - How to Figure the Credit.  A similar exception applies with respect to S corporations. 
  • If the partnership has only U.S. source income and none of the partnership’s income or deductions must be sourced or allocated and apportioned by the partner, and all partners are less-than-10% limited partners, the partnership need not complete Schedule K-2, Part II. Further, if the partnership has only U.S. source income and none of the partnership's income or deductions must be sourced or allocated and apportioned by the partner, Schedule K-3, Part II is not completed for its partners that are less-than-10% limited partners.  
  • If the partnership knows that all its partners are less-than-10% limited partners, the partnership does not need to complete Schedules K-2 or K-3, Part III, Section 2. Further, the partnership must only complete Schedule K-3, Part III, Section 2 with respect to its partners that are not less-than-10% limited partners.    

The IRS is providing an additional exception for tax year 2021 to filing the Schedules K-2 and K-3 for certain domestic partnerships and S corporations. To qualify for this exception, the following must be met:

  • In tax year 2021, the direct partners in the domestic partnership are not foreign partnerships, foreign corporations, foreign individuals, foreign estates, or foreign trusts. 
  • In tax year 2021, the domestic partnership or S corporation has no foreign activity, including foreign taxes paid or accrued or ownership of assets that generate, have generated, or may reasonably expected to generate foreign source income (see section 1.861-9(g)(3)).
  • In tax year 2020, the domestic partnership or S corporation did not provide to its partners or shareholders nor did the partners or shareholders request the information regarding (on the form or attachments thereto):
    • Line 16, Form 1065, Schedules K and K-1 (line 14 for Form 1120-S), and
    • Line 20c, Form 1065, Schedules K and K-1 (Controlled Foreign Corporations, Passive Foreign Investment Companies, 1120-F, section 250, section 864(c)(8), section 721(c) partnerships, and section 7874) (line 17d for Form 1120-S).
  • The domestic partnership or S corporation has no knowledge that the partners or shareholders are requesting such information for tax year 2021.

If a partnership or S corporation qualifies for this exception, the domestic partnership or S corporation does not need to file Schedules K-2 and K-3 with the IRS or with its partners or shareholders.  However, if the partnership or S corporation is subsequently notified by a partner or shareholder that all or part of the information contained on Schedule K-3 is needed to complete their tax return, then the partnership or S corporation must provide the information to the partner or shareholder.  If a partner or shareholder notifies the partnership or S corporation before the partnership or S corporation files its return, the conditions for the exception are not met and the partnership or S corporation must provide the Schedule K-3 to the partner or shareholder and file the Schedules K-2 and K-3 with the IRS.

  • The instructions for the 8082 say on page 1: “Also use the form to notify the IRS if you did not receive Schedule K-1, Schedule Q, or a foreign trust statement from the foreign trust by the due date for filing your return (including extensions)”.  If you believe that you should have received a Schedule K-3 but did not, use Form 8082 to notify the IRS. The IRS will publicly release a new cover sheet for Form 8082 in the near future containing similar guidance.
  • According to page 1 of the Instructions to Schedules K-2 and K-3 (Form 1065) and page 1 of the Instructions to Schedules K-2 and K-3 (Form 1120-S), a partnership and S corporation are only required to complete the relevant portions of Schedules K-2 and K-3.   See FAQ #17 for a link to the instructions.
  • No.  If the filer meets such an exception to filing Forms 5471, 8865, and/or 8858, the filer is not required to complete and attach those forms.  However, the filer must still attach to the Forms 1065, 1120-S, and the tax return of the U.S. person filing Form 8865, any required statements to qualify for the exception to filing the Forms 5471, 8865, and/or 8858.  Further, in the case of the Form 5471 multiple filer exception, the partnership or S corporation must provide on the Schedule K-3 to its partners or shareholders any information that the partnership or S corporation receives from the person required to file the Form 5471 and that is requested by the Instructions to the Schedules K-2 and K-3, such as Schedule Q (Form 5471) information, if applicable. 
  • Yes, page 8 of the Instructions to the Schedules K-2 and K-3 (Form 1065) refers to the Instructions to Forms 1116 and 1118 for exceptions from the requirement to report gross income and taxes by foreign country or U.S. possession, including for regulated investment companies.  See also page 8 of the Instructions to the Schedules K-2 and K-3 (Form 1120-S) and page 7 of the Instructions to the Schedules K-2 and K-3 (Form 8865).  See FAQ #17 for a link to the instructions.
  • A filer is not required to complete Section 1 of Part III unless either (1) the partnership or S corporation incurs research & experimental expense or (2) the partner or shareholder is expected to license, sell, or transfer its intangible property to the partnership or S corporation (as provided in §1.861-17(f)(3)).  This clarification will be added to the tax year 2022 instructions.  However, filers may choose to follow this clarification for tax year 2021.
  • No, if a foreign partnership marks to market stock of a PFIC as described in Treas. Reg. §1.1291-1(c)(4), the filer of Form 1065 does not need to report information about the PFIC on Part VII.  The filer should report the partnership’s MTM gain or loss on Schedule K (Form 1065) and report the partners’ shares of such amounts on Part III of Schedule K-1 (Form 1065).  Similarly, a U.S. person filing Form 8865 with respect to a foreign partnership that has made an MTM election described in Treas. Reg. §1.1291-1(c)(4) for a PFIC should report the partnership’s MTM gain or loss on Schedule K (Form 8865) and report the partners’ share of such amounts on Part III of Schedule K-1 (Form 8865). 

There may, however, be instances in which the partner will need additional information from the partnership to meet its tax obligations with respect to the PFIC, such as when section 1291 rules apply because the stock was not marked in the first year of the holding period.  In such instances, the partnership should provide the needed information and may use Part VII to do so.

  • No, Part VIII (Form 1065) and Part VII (Form 1120-S) are not required to be completed with respect to dormant foreign corporations.  This clarification will be added to the tax year 2022 instructions.  However, filers may follow this clarification for tax year 2021.
  • The following approach is solely a recommendation for tax year 2021, and the IRS recognizes that partnerships may have taken other approaches.  The IRS appreciates comments on this approach and whether there are other approaches to reporting OID on Part X of Schedules K-2 and K-3.  The IRS will take these comments into account for the tax year 2022 Instructions to the Schedules K-2 and K-3.

A partnership generally reports OID on Schedules K and K-1 (Form 1065) in the taxable year the OID accrues.  However, the instructions to Part X of Schedules K-2 and K-3 (Form 1065) require the partnership to report OID only when it is taxable to foreign partners (i.e., when there is a payment or gain on the OID instrument).  To reconcile Schedules K-2 and K-3 reporting of OID with Schedules K and K-1 reporting of OID and to provide foreign partners with the information necessary to complete their returns, the IRS recommends the following approach for reporting OID on Part X.

Accrued OID Reported on Form 1065
The amount of accrued OID reported on Schedules K (Form 1065) which is not taxable to foreign partners should be reported as interest income in column (f) (U.S. source (other)) of Part X, Schedule K-2. The IRS recommends that the partnership attach a statement to Form 1065 with respect to Part X clarifying that these amounts are not taxable to foreign partners and need not be reported on the foreign partner’s tax return.  The partnership should take a similar approach for reporting distributive share amounts to a foreign partner on Schedule K-3.

OID Payments or Gains Taxable on a Gross Basis to a Foreign Partner
When the partnership receives payments on the OID instrument or gain on the sale or exchange of the OID instrument that are taxable on a gross basis to foreign partners, these amounts should be reported in column (e) (U.S. source (fixed, determinable, annual, or periodical - FDAP)) as interest income or gain, as appropriate.  These amounts should also be entered as a negative adjustment in column (f) to ensure that the total OID reported on Part X reconciles with OID reported on Schedule K (Form 1065).  Additionally, the IRS recommends attaching a statement explaining that the negative adjustment in column (f) is for reconciliation purposes only and is not relevant to the foreign partner’s tax liability and therefore need not be reported on the foreign partner’s tax return.  The partnership should take a similar approach for reporting distributive share amounts to a foreign partner on Schedule K-3.

Example
In addition to other income and expense items, a partnership accrues $100 OID in year 1 reported on Schedule K (Form 1065).  On Part X of Schedule K-2 for year 1, the partnership should report this amount as interest in column (f) (such amount is also included in column (a) for the total).  In year 2, the partnership receives a payment with respect to the same instrument that results in $50 of gross income taxable on a gross basis to its foreign partners.  On its Part X of Schedule K-2 for year 2, the partnership should report $50 as interest in column (e) and ($50) as a reconciliation adjustment in column (f).  The partnership should take the same approach for reporting distributive share amounts to a foreign partner on Schedule K-3 in both years 1 and 2.

  • The tax year 2022 instructions will clarify the reporting on Section 3, lines 2b, 3a, and 3b of Part X, Schedules K-2 and K-3 (Form 1065) as follows:
    • Line 2b. Average worldwide assets. Report the partnership’s basis in its average worldwide assets for purposes of Treasury Regulation section 1.882-5(b) using the average amount as defined in Treasury Regulation sections 1.882-5(b)(3) and 1.884-1(d)(3)(ii).
    • Line 3a. Average U.S.-booked liabilities of the partnership. Enter the partnership's average U.S.-booked liabilities as defined in Treasury Regulation section 1.882-5(d)(2) using the average defined in Treasury Regulation section 1.882-5(d)(3).
    • Line 3b. Directly allocated partnership indebtedness. Enter the portion of the principal amount of the partnership’s indebtedness outstanding at year end that meets the requirements of Temporary Regulation section 1.861-10T(b) or (c), as limited by Temporary Regulation section 1.861-10T(d)(1), as described in Treasury Regulation section 1.882-5(a)(1)(ii)(B).  See Treasury Regulation section 1.861-10T(d)(2). 

A partnership may choose to follow the above instructions for tax year 2021 Schedules K-2 and K-3 (1065).