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Do You Need to File Schedules K-2 & K-3? A Look at Requirements, Exceptions/Relief, Filing Issues

Starting with the 2021 tax year, IRS forms K-2 and K-3 are new schedules that may need to be included with 1065 (Partnerships), 1120S (S Corporations), or 8865 (Certain Foreign Partnerships) filings. These are all pass-through entity filings that include Schedule K-1, which reports a partner’s or shareholder’s share of the entity’s profits, losses, deductions, and credits for the year, and the K-2/K-3 schedules are an extension of that.

Specifically, these forms go into greater detail regarding items of international relevance that may impact foreign reporting at the individual member or shareholder level. These schedules were created to accommodate international provisions enacted as part of the Tax Cuts and Jobs Act in 2017, which increased the amount and type of information needed to calculate items of foreign tax relevance (for example, calculating the foreign tax credit).

Who Must File?

The general guidance from the IRS states that a pass-through entity “with items of international tax relevance” would be subject to these new reporting requirements. However, there has been a great deal of confusion about what this means. The basic interpretation might be that if a pass-through entity has no international activities and no foreign members or shareholders, the K-2/K-3 filing requirement won’t apply – however, that is not necessarily the case.

IRS updated its instructions to state that an entity “with no 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.” The most common example of this would be for partners/shareholders who claim a foreign tax credit on their individual returns – they may need information from the K-2 and K-3 filings to complete the associated form and calculate the credit.

Your tax professional will ask you and all of your partners and shareholders about your foreign activity, so please be patient with the extra questions this year. (It’s not us; it’s the IRS!) Also, any one partner could ask for Schedules K2 and K3, and this would mean that they need to be completed regardless of whether any partner/shareholder had foreign activity. Simply by the partner’s asking, it triggers the requirement.

The big takeaway here is that items of international tax relevance and the K2/K3 requirement should be determined at the partner/shareholder level, not just the entity level.

Exceptions/Relief

IRS released initial information regarding transitional relief, knowing that there would be an adjustment period for entities to achieve compliance. Per Notice 2021-39, certain transitional penalty relief could be granted to those filers who made a good faith effort to comply with the new reporting requirements.

However, after significant pushback, the IRS announced that it would provide additional relief for 2021. S corps and partnerships that have no foreign activities, no foreign partners or shareholders, and no knowledge of partners’ or shareholders’ need for information on international items of relevance will not be subject to the K-2/K-3 filing requirements for tax year 2021. There is no indication at this point that the relief will extend beyond the 2021 tax year, so these entities should be prepared to complete the filings for 2022 and beyond.

Filing Issues

Because Schedules K-2 and K-3 are new for 2021, it has taken/will take some time for tax software programs to have electronic filing capability for these forms. If a tax return was or will be electronically filed prior to the availability dates listed below, the schedules much be submitted as separate PDF files attached to the return (most tax programs should be able to accommodate electronic attachment of miscellaneous PDF forms).

Per IRS, here are the availability dates for electronic filing of the K-2/K-3 forms:

  • With Form 1065: March 20, 2022
  • With Form 1120-S: mid-June 2022
  • With Form 8865: January 2023

Although IRS expects that all of these will be available for e-filing for the upcoming (2022) tax year, the ability to file via PDF attachment will still be available, if preferred.

Frequently Asked Questions/Questions or Feedback for IRS

IRS has created a K-2 and K-3 Frequently Asked Questions (FAQ) page, which it has been keeping updated as new information comes to light. Be sure to monitor this page for any new updates: Schedules K-2 and K-3 Frequently Asked Questions (Forms 1065, 1120S, and 8865) | Internal Revenue Service (irs.gov) IRS has also provided an email address for questions/comments that come up, and is welcoming feedback from taxpayers about this new compliance requirement: lbi.passthrough.international.form.changes@irs.gov.

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How to Write a Refund Policy

A refund policy defines the processes and rules for when customers want their money back and want to return the products or services they purchased from you. It’s often required by your credit card or shopping cart company as part of maintaining PCI (Payment Card Industry) compliance. Plus, it’s just a good, fair business practice to post one.

As a business owner, you can set your own refund rules. The important thing is that they are communicated clearly to the customer in advance of their purchase.

A good refund policy answers the questions that customers have when the item they purchased from you does not work out. It reduces conflict and ambiguity, and improves customer service. It also helps your employees work with customers’ expectations, by allowing them to refer to the posted policy that a customer can see with their own eyes.

Here are some of the components you’ll want to address in your refund policy:

Items to be returned: Which items can be returned and which can’t? Some products, after opening, like food, simply can’t be returned safely. You might still honor a refund of money even if the item can’t be returned or re-sold.

Condition of items: You may want to stipulate for some returned items that they are in a condition to be re-sold. That means the customer may need to return packaging as well as the item in order to qualify for a refund.

Time limit: How long from the date of purchase do customers have to return the item and ask for a refund? Common time limits range from 7 to 30 days.

Shipping: If shipping cost is involved, who will pay it?

Processing time: How long will it take to receive a refund once the item is returned?

Money: How will the money be returned? Will it be on the credit card used? What if it is cash or a check? Or will you give store credit only?

Requirements: Will customers need to fill out a form, request refund approval, or use a specific shipping return label?  What instructions do you need to provide them for proper return requests and processing?

Fees: Will there be a re-stocking fee, cancellation fee, return processing fee, or any other fee that reduces the amount of the refund?

The first step is to decide the answers to all of the above questions. You might be tempted to have a “no returns, no refunds” policy, and this could be the right thing in many cases. However, the refund policy is a chance to build trust with the customer, and a rigid one could cause lost sales. Often a “no questions asked” refund policy can increase sales in the long term. Only a very tiny percentage of people will take advantage of it.

Once you have determined the answers to your refund policy, you can write up the policy. Post it on your website and near your cash register or checkout areas of your store.

Next, make sure you have a smooth process in place for handling returns on a timely basis. Most stores have a separate checkout area or customer service desk to process returns so that they don’t slow down the regular check-out lines. Employees should be trained on how to talk with the customers, how to accept the returned items back into inventory for resale or return back to the vendor, and how to use the cash register or shopping cart system to process the returns.

You can even turn returns into a positive experience for everyone. If an item is the wrong size, it may be able to be converted into an exchange for a different size so the sale is not lost. A great sales person can also provide upsell opportunities for new or similar items to the returned item. Proactively, your store can sell warranties at the time of purchase for selected items.

The more customers you have, the more chances there are of having a customer who asks for a refund. Be prepared with a clear, fair, well-documented refund policy.

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What is a 529 Plan?

A 529 Plan is an investment account that offers tax benefits when used to pay for qualified education expenses.  Investments grow tax free and withdraws are tax- and penalty-free as long as they are used to pay for eligible expenses.

Most states offer their own 529 plan; you don’t have to be a resident of the particular state in order to establish an account.  Many states also offer a state income tax deduction or tax credit for 529 plan contributions.  There are even a handful of states that will give you a tax benefit for contributing to a different state’s 529 plan!

Who can contribute to a 529 Plan?

Anybody!  The account has one owner and one beneficiary, but anyone (friends, family members) can contribute.

What happens if the beneficiary doesn’t use all of the funds?

The owner of the 529 plan is always in control of the account.  They can name another person as a beneficiary (check with your 529 plan for eligibility), they can use the money themselves for qualified education expenses, or withdraw the funds (penalty applies).

Can 529 Plan Funds be used for other types of schooling?

You can withdraw up to $10,000 per year to pay for private elementary or high school tuition, penalty-free.  Some states don’t conform to federal law, so be certain to check with your tax professional for your individual circumstances.

Eligible expenses related to attending trade schools, vocational programs, and registered apprenticeship programs are also allowed under a 529 plan.

What is a qualified expense?

For a withdraw to be free from penalty, the funds have to be used for a qualified expense.  Qualified expenses include:

Tuition—full or part time attendance at an accredited institution

Room and Board—for on-campus students, this is the cost of housing and a meal plan.  For off campus students, rent and food are a qualified expense, but the amount can’t exceed the school’s published Cost of Attendance.  For example, if the school charges $7,000 per semester for housing, but the student’s off-campus housing costs $8,000 per semester, only $7,000 is a qualified expense and can be withdrawn tax- and penalty-free.  The remaining $1,000 either needs to be paid out-of-pocket or would be subject to tax and penalties if paid from the 529 plan

Books and Supplies – textbooks, ebooks, lab fees, course fees, pens, paper, etc. required for a class is a qualified expense

Technology – computers, printers, and internet service are qualified expenses while you are enrolled in college

Student Loan Repayment – the IRS allows you to take up to $10,000 from a 529 plan to repay student loans.  Check with your state to ensure that they conform to this law; some states do not and will assess taxes/penalties on the withdraw.

What isn’t a qualified expense?

There are certain expenses that seem like they should be a qualified expense but actually aren’t covered.  Examples include:

Health Insurance

Fitness Club Memberships

Transportation

Cell Phone Plans

College Application and Testing Fees

An Easy Way to Save on Taxes

529 plans are a very common way to save taxes for families with children planning to go to college. If anyone in your household is currently attending educational programs or even plans to in the future, give us a call, and let us help you save on taxes with this deduction.

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Why Are You in Business? Crafting Your Mission, Vision, and Values Statements

Most large businesses have developed mission, vision, and values statements to help guide them and inform stakeholders about the company’s strategic direction. Going through this strategic exercise is a wonderful idea for even the smallest business as well.

A company’s mission statement lists its core purpose and desired impact for employees, customers, owners, and other stakeholders. A vision statement defines what the company wants to be. A values statement describes what the company stands for.

It’s a perfect activity for business owners to answer and remember why they built the business in the first place. It also serves to correct and re-align the trajectory of the business.

Mission Statement

Start by asking what impact you want your business to have on the outside world. Here are some mission statement examples that are frequently quoted:

Harley-Davidson: More than building machines, we stand for the timeless pursuit of adventure. Freedom for the soul.

Disney: The mission of The Walt Disney Company is to entertain, inform and inspire people around the globe through the power of unparalleled storytelling, reflecting the iconic brands, creative minds and innovative technologies that make ours the world’s premier entertainment company.

Nike: Nike exists to bring inspiration and innovation to every athlete* in the world. Our purpose is to move the world forward through the power of sport – breaking barriers and building community to change the game for all. *If you have a body, you are an athlete.

Notice how each one is short and simple to understand. They focus more on the big-picture benefits they bring to customers and less on how they will get there.

To write your own mission statement, ask yourself what your business’s purpose is and how you will impact your customers’ lives with your products and services.

Vision Statement

A vision statement is big, bold, and futuristic. What do you want your company to be?

Here are a few examples:

Harley-Davidson: Building our legend and leading our industry through innovation, evolution, and emotion

Deloitte: We aspire to be the Standard of Excellence, the first choice of the most sought-after clients and talent.

Amazon: Amazon strives to be Earth’s most customer-centric company, Earth’s best employer, and Earth’s safest place to work.

What do you want your company to become?  That’s your vision statement.

Values Statements

Values statements are typically a set of adjectives or statements that answer what the company stands for. They can be in the form of leadership principles, core values, or a similar format. These days, they often include values on environmental, social, climate, global, human rights, diversity and inclusion, sustainability, and many other current issues. They can take the form of additional strategic statements on each one of these issues.

Sample values statements can be found in the company’s annual report as well as the About or Company section of their website.

Here are some examples:

Harley-Davidson Principles:

Communication – Communicate with purpose, structure, facts and inspiration

Agility – Accelerate, innovate and thrive in a rapidly changing environment

Impact – Focus on impact, not process, and be outcome driven

Simplicity – Pursue the simplest path to achieve each outcome

Speed – Don’t let perfection get in the way of process and pace

Culture – Be fair, honest, positive and creative. Strive to win and have fun.

Courage -Take risks and go against the norm

Judgment -Think strategically and make informed decisions

Focus – Focus on a short list of meaningful opportunities that build desirability

Lean – Maximize impact with limited resources

Coca-Cola Behaviors We Focus on:

Curious

Empowered

Inclusive

Agile

Merck Values:

Patients first

Respect for people

Ethics and integrity

Innovation and scientific excellence

Your mission, vision, and values statements will help you communicate the qualities of your business. It can help in hiring to see if a candidate’s individual values align with the core corporate values, and with customer acquisition when prospects see what your company is about. It can also help you remember your roots and why you work so hard every day.

We’d love to hear from you when you write up your mission, vision, and values statements.

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Understanding Your IRS Notice

Dealing with the IRS can be stressful! There are taxpayers who receive an IRS notice and because they are so fearful, they will pay the notice without verifying the accuracy. The IRS may not have all the facts, so do not pay anything without checking the details. Also, do not ignore any letter sent by the IRS—doing so will only make the situation worse. Understanding your IRS notice empowers you to make the most informed decision for your situation.

The IRS sends notices and letters for the following reasons:

  • You have a balance due
  • You are owed a larger or smaller refund
  • The IRS has a question about your tax return
  • The IRS needs to verify your identity
  • The IRS needs more information to process your tax return
  • The IRS changed your return
  • There are delays in processing your return

(Remember, the IRS will never call you on the phone to collect money or verify your identity; if someone says they are the IRS on the phone, it’s a scam! Don’t fall for it.)

First, check the type of notice that the IRS sent you (example: Notice CP2000 indicates that the information contained in the tax return doesn’t match what was reported to the IRS by third parties) and review which tax year this applies to. This information will be included in either the upper right- or left-hand corner of the notice.

Read the notice carefully. If the tax return was changed by the IRS, compare the information listed on the notice with your tax return. Review line items thoroughly and determine what numbers are different.

In 2020 and 2021, the IRS fell behind processing returns and especially those that were filed on paper. That resulted in a LOT of IRS letters going out that were just plain wrong because the paper returns had not been entered into the system yet.

If you agree with the notice and there is a balance owed, make certain to pay it by the due date to avoid additional fees and penalties. If you can’t afford to pay the full amount listed, pay as much as you can now. If you need to pay over time, consider applying online for an installment agreement.

If you disagree with the notice, be sure to follow the instructions included in the letter that indicate how to dispute their findings. Often, you will need to provide not only an explanation of why you disagree, but also the documents that support your position. The notice will also tell you the timeframe you need to respond in and how to do it (ex: mail or fax). Responding timely preserves your right to appeal an IRS decision if you don’t agree with it!

And this is where you will probably want to get expert representation anyway, especially if the IRS says you owe a lot. The only three types of tax professionals that can represent you in front of the IRS are CPAs, Enrolled Agents, and attorneys.

Always provide any IRS correspondence to your tax preparer. There may be information contained in the notice that impacts the following tax year, which is important for your tax preparer to be aware of. Most of all, reach out to your tax preparer for assistance if you do not fully understand the notice. Getting them involved early could save you a lot of worry, and maybe even some money if penalties can be waived.