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.

Table of Contents

  1. Schedule K-2/K-3 Applies to Pass-Through Entities with International Activity
  2. IC-DISC Dividends in a Pass-Through Structure
  3. Foreign-Source Nature of IC-DISC Dividends
  4. Key Reporting Considerations for Schedule K-2/K-3
  5. What You Should Do Now

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

If you want to take your international business to the next level, IC-DISC is the answer. Check out our related articles:

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. He is licensed as a Certified Public Accountant (CPA) in both Massachusetts and Rhode Island. Recognizing a need for specialized expertise in the Interest Charge-Domestic International Sales Corporation (IC-DISC), Paul has focused ETM’s services on helping businesses maximize their tax savings through this unique export incentive. With over 25 years of experience, he leads a team of skilled CPAs based in Boston, MA, providing expert IC-DISC and international tax consulting to companies across the U.S.

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