2025 Update — Partnership Schedules K-2/K-3 & IRC §1061 (Carried Interest)
In 2025, the IRS further tightened the reporting rules for international partnership activities and clarified the scope of the carried interest rule under IRC §1061.
Schedules K-2 and K-3 now apply broadly to partnerships with even minimal foreign-source items, and the 3-year holding rule for carried interests continues to reshape how fund managers are taxed.
This post breaks down what these updates mean for tax professionals and investors filing Form 1065 in 2025.
1️⃣ Expanded K-2/K-3 Reporting Rules
Starting in 2025, the IRS expects nearly all partnerships filing Form 1065 to consider whether foreign-related items exist.
If there is any possibility of foreign-source income, withholding, or creditable foreign tax, Schedules K-2 (entity-level reporting) and K-3 (partner-level detail) must be attached.
Even a single foreign partner or one account earning foreign-source dividends can trigger the K-2/K-3 requirement.
Missing these schedules may result in penalties of up to $290 per partner per month (2025 rate).
These forms also support individuals claiming Form 1116 (Foreign Tax Credit) or Form 2555 (Foreign Earned Income Exclusion) by passing through accurate foreign income and tax data.
2️⃣ IRC §1061 — Three-Year Carried Interest Rule
Under IRC §1061, long-term capital gains from carried interests are recognized only when the underlying asset has been held for more than three years.
Gains realized earlier are reclassified as short-term, taxed at the top ordinary income rate (up to 37% in 2025).
The rule targets Applicable Partnership Interests (API) received for services rather than capital contributions.
Suppose a hedge-fund GP received a carried-interest allocation in 2022 and sold the asset in 2024 (after two years).
Because the holding period is less than 36 months, the profit is treated as short-term capital gain.
Waiting until 2025 to sell (after three years) would qualify for the 20% long-term rate instead.
Partnerships must separately track service-based and capital-based interests, ensuring APIs are properly identified and the required §1061 computations are disclosed to partners.
3️⃣ Practical Implications for Partnerships and Funds
- Determine K-2/K-3 filing responsibility early — “no foreign activity” statements are acceptable if true.
- Attach K-2 to Form 1065 and provide K-3 to each partner electronically or in print.
- Track API holding periods asset-by-asset to document §1061 compliance.
- Some states (such as California and New York) require additional carried-interest disclosures.
When e-filing Form 1065, many rejections occur due to missing K-2/K-3 attachments.
Even if there is no foreign income, include the “No foreign transactions reported” statement to avoid IRS errors.
4️⃣ EA Case Example — K-2/K-3 & §1061 in Practice
Blue Harbor Partners LLC operates solely in the U.S. but receives 10% of its dividend income from a foreign ETF.
Because foreign-source income exists, the partnership must file K-2/K-3 to disclose foreign tax credit information.
In addition, a GP receiving performance allocation less than three years old will have that portion reclassified under §1061.
These rules can affect even small LLCs or investment clubs holding foreign securities.
Proper K-2/K-3 disclosure and §1061 tracking ensure that partners receive accurate basis and gain information for Form 1040 reporting.
5️⃣ Key Takeaways & Resources
Transparency is the theme of 2025 partnership filings.
K-2/K-3 disclosures enable the IRS to trace foreign income accurately, while §1061 enforces fair tax treatment on carried interests.
Staying current with these rules helps avoid penalties and maintains investor trust.
👉 Official IRS References:
핑백: LLC · QJV · Partnership Formation & Election
핑백: Partnership Taxation Basics
핑백: Part 5: Partner Basis Calculation Guide — Understanding Outside Basis, Debt Share & Distributions
핑백: Guaranteed Payments for Partners 2025
핑백: Partnership Termination & Year-End Wrap-Up