Update on the IC-DISC - Schedule K-2/K-3 and the IC-DISC Dividend

Update on the IC-DISC – Schedule K-2/K-3 and the IC-DISC Dividend

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The IRS’s expanded international reporting requirements have made it essential for S corporations and partnerships with IC-DISCs to understand how to properly report dividends on Form Schedule K-2/K-3. Below is a summary of key developments that may affect Forms 1120S or 1065.

1. Schedule K-2/K-3 Applies to Pass-Through Entities with International Activity

  • Effective in 2022, both partnerships and S corporations must file Schedule K-2 and K-3 if they have international tax items.
  • These forms report details on foreign-source income, foreign taxes paid, and calculations for the foreign tax credit (FTC).
  • Incomplete or incorrect filings can delay partner/shareholder tax returns and compromise the ability to fully utilize a FTC.
A group of people wearing safety vests are next to shipping containers, providing an update on IC-DISC dividends.

2. IC-DISC Dividends in a Pass-Through Structure

  • Many exporters utilize an S corporation or partnership as the parent entity of an IC-DISC.
  • The IC-DISC pays qualified dividends to the parent entity, which then distributes that income to shareholders or partners through Schedule K-1.

3. Foreign-Source Nature of IC-DISC Dividends

  • While an IC-DISC must be incorporated in the U.S. under Treas. Reg. § 1.992-1(a)(1), its dividends are treated as foreign-source income.
  • Under Rev. Rul. 73-68 and Treas. Reg. § 1.904-4(b)(3), these dividends are classified as “specified passive category” foreign income for FTC purposes.
  • This distinction can be easily overlooked but has important implications for proper FTC reporting and sourcing rules.

4. Key Reporting Considerations for Schedule K-2/K-3

When preparing Schedules K-2 and K-3:

  • Include the dividend income in Part II of Schedule K-2 and pass it through to Schedule K-3.
  • Source the income as foreign, not domestic, despite the IC-DISC being a U.S. entity.
  • Classify it as specified passive category income for FTC limitation purposes.
  • Accurate reporting helps shareholders claim FTCs.

What You Should Do Now

  • Review your IC-DISC structure and whether your entity’s dividends are properly sourced.
  • Ensure that your tax preparers and advisors are familiar with the nuances of IC-DISC and K-2/K-3 reporting.
  • Reach out to our team with any questions.

Author

  • Paul Ferreira, CPA, is the President and founder of Export Tax Management (ETM), which he established in 2008 after over ten years of experience in international tax. Recognizing a need for specialized expertise in the Interest Charge-Domestic International Sales Corporation (IC-DISC), Paul focused ETM’s services on helping businesses maximize their tax savings through this unique export incentive. With over 25 years of experience, Paul leads a team of skilled CPAs based in Boston, MA, providing expert IC-DISC advisory to companies across the U.S.

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