White paper

K-1 Aggregation and International Filing Requirements

The current practice of K-1 reporting has led to significant complexity and risk associated with federal, state, and international reporting requirements. Many that practitioners understand, and others that creep up in the event of a sale of partnership asset. The authors walk through these complexities in this series of white papers.

Thomson Reuters and Crowe LLP entered into a strategic collaboration to help tax professionals address the burdensome manual work related to Schedule K-1 forms.

The authors are tax accounting specialists from Crowe.

Geralyn R. Hurd, CPA
John V. Woodhull, JD
Jonathan M. Cesaretti, JD
Kristin N. Kranich, CPA

K-1 Aggregation and International Filing Requirements

Our previous two articles in this series, “The Four Dimensions of K-1 Aggregation: A Federal Overview” and “State Complexities in K-1 Aggregation,” focused on issues associated with federal and state filing requirements due to investments in alternatives. Federal and state issues were associated with income tax reporting. International compliance is largely due to the transfer of cash or goods outside of the U.S.

Foreign information reporting

In recent years, the Internal Revenue Service (IRS) has placed a special emphasis on the reporting of transfers from U.S. persons to foreign entities. To ensure compliance with what is essentially information reporting, the IRS has imposed significant penalties on U.S. taxpayers who do not comply with these reporting requirements. 

While investors make direct investments in foreign corporations and foreign partnerships that are large enough to create foreign information reporting obligations, it is unlikely that many investors, absent their partnership investments, would have significant enough investments to require the preparation of the following:

  • Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships
  • Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation
  • Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)
  • Form 5471, Information Return of U.S. Returns With Respect to Certain Foreign Corporations
  • Form 8621, Information Return by a Shareholder of a Passive Foreign Investment Company or   a Qualified Electing Fund

Most foreign information reporting is triggered either by the size of the investment or the ownership interest acquired. Although there are several reporting thresholds, the primary threshold that affects investors is the transfer or investment of cash in excess of $100,000 though non-cash transfers have no dollar limit. Domestic U.S. partnerships with investments in foreign corporations or foreign partnerships must provide enough information about their investments in the Schedule K-1 so that a partner can tell whether its proportionate investment exceeds the reporting thresholds,   in which case a Form 8865 or a Form 926 must be attached to the entity’s tax return. 

The problem that investors face is that their foreign reporting obligations are based on all their proportionate shares of partnership investments computed on a cumulative basis. Thus, if an investor has an ownership interest in 500 domestic partnerships, and 10 of these partnerships have invested in the same foreign partnership or corporation, the tax-exempt investor’s combined investment may exceed $100,000 on a cumulative basis. However, to determine if the reporting threshold has been exceeded, every footnote reporting foreign corporate or partnership investments will have to be tabulated by the investor. This will require partners to identify and calculate the information they receive in the footnotes of their Schedules K-1 about the partnerships’ underlying investments in foreign corporations and foreign partnerships. An investor who has hundreds of footnotes to review and categorize may determine, at the end of this exercise, that there is no foreign filing obligation because the $100,000 reporting thresholds have not been reached.

As with so much of the Schedule K-1 information reporting, one or two or 10 Schedules K-1 are manageable, but hundreds put a real strain on the tax professionals conducting this information- gathering process. There is added complexity due to the rolling 12-month rule that requires this aggregation and analysis to be done not just by aggregating all K-1s in a single year but also reviewing all prior-year transfers to test for the rolling 12-month reporting requirement.  

TCJA increased international compliance burden

The Tax Cuts and Jobs Act of 2017 (TCJA) made significant changes to the international tax rules. As a result, investors with outbound investments now face increased compliance burdens. Most changes took effect January 1, 2018, while other changes were retroactive, taking effect as of the beginning of the 2017 tax year.

Ready to read more? 

Keep reading to learn more about the increased compliance burden of TCJA for investors with outbound investments.