Part II. Foreign Tax — 2025 Inst 1065 (Schedule K-3) (PDF)

Column (a). U.S. source. Don’t report amounts in this column on Form 1116 or 1118 unless you elect to re-source such income under an applicable U.S. income tax treaty. See sections 904(d)(6) and 865(h). See the instructions for Forms 1116 and 1118 for income re-sourced by treaty reported as a separate category of income.

Columns (b) through (e). Foreign source. Add the amounts reported in these columns to your other income in these separate categories and report the total amounts on the applicable Form 1116, Part I; or Form 1118, Schedule A.

Exception. If you’re a limited partner, you hold less than 10% of the value of the partnership, and you didn’t hold your interest in the ordinary course of the partner’s active trade or business, then any amounts reported on Schedule K-3 in the following locations should generally be reported as passive category income.

Part II, Section 1, columns (b), (d), and (e).
Part III, Section 1, columns (b), (d), and (e).
Part III, Section 3, columns (c) and (d).
Part III, Section 5, columns (b), (c), (e), and (f).

Deductions reported in columns (b), (d), and (e) of Part II, Section 2, should generally be reported as reducing passive category income. Similarly, any foreign income taxes paid or accrued on foreign source income in columns (b), (c), (e), and (f) of Part III, Section 4, should generally be assigned to passive category income; see Regulations section 1.904-4(n)(1)(ii). If you’re a limited partner that owns less than 10% of a capital and profits interest in the partnership, Part III, Section 2, wasn’t completed by the partnership; see Regulations section 1.861-9(e)(4). See section 904(d)(2)(B)(iii)(II) and Regulations section 1.904-4(c) for an exception to passive category if income is subject to a high rate of foreign tax.

Column (f). Sourced by partner. You must determine the source and separate category of the income reported in this column. The income in this column will generally be with respect to sale of personal property other than inventory, depreciable property, and certain intangible property and will generally be sourced under section 865. This column might also include foreign currency gain on a section 988 transaction. If you’re a U.S. citizen or resident, sales and gains reported in this column will generally be U.S. source income and not reported on Form 1116 or 1118 unless you elect to re-source such income under an applicable income tax treaty. There are certain exceptions, for example, a U.S. citizen or resident with a tax home (as defined in section 911(d)(3)) in another country is treated as a nonresident if an income tax of at least 10% is imposed by and paid to a foreign country regarding such sale. See the instructions for box 1 of Part I, earlier. Also, the source of foreign currency gain or loss on section 988 transactions may be determined by reference to the residence of the QBU on whose books the asset, liability, or item of income or expense is properly reflected. See the Instructions for Form 1118 and Pub. 514 for additional details.

Section 1—Gross Income (Lines 1 Through 24) Form 1118, Schedule A, requires a corporation to separately report certain types of gross income by source and separate category. Schedule K-3, Part II, lines 1 through 23, generally follow the separately reported types of gross income on Form 1118, Schedule A. Individuals must follow the same sourcing rules, but Form 1116 only requires reporting of total gross income from foreign sources by separate category. Therefore, those required to file Form 1116 would report the amount from Schedule K-3, Part II, Section 1, line 24, taking into account section 904(b)(2) and PTEP adjustments, by country on their Form 1116, Part I, line 1a. Because all gross income is reported on one line on Form 1116, the remaining instructions generally refer only to Form 1118 reporting.

Country code. Lines 1 through 24 require the partnership to report for each gross income item, on a separate line (A, B, or C), the two-letter code from the list at IRS.gov/CountryCodes for the foreign country or U.S. territory within which the gross income is sourced. If a type of income is sourced from more than three countries, a statement is attached to expand Schedule K-3, Part II, for that type of income to report the additional countries.

Note: Schedule K-3 reports gross income by country or U.S. territory because such information is requested on Forms 1116 and 1118. Income and taxes are reported by country on Forms 1116 and 1118 so that the IRS may, for example, initially evaluate whether taxpayers are claiming credits for compulsory payments to foreign governments.

If applicable, the partnership entered in column (f) the foreign country to which the partnership paid tax of at least 10% of the gain. See sections 865(e) and 865(g).

Each gross income item (for example, sales vs. interest income) may have different countries listed on A, B, C, etc., given that the partnership might not have sales income and interest income, for example, from the same country. Line 24 should add each country’s total income reported on Part II, regardless of which line such income is reported, whether A, B, C, etc.

Note: For column (f) of Part II, if the partnership entered the code XX, it was because it couldn’t determine the country or U.S. territory from which the gross income is sourced because the source is determined by your residence, or for pass-through entities, the residence of the first non-pass-through partner.

Exceptions. The instructions for Forms 1116 and 1118 specify exceptions from the requirement to report gross income by foreign country or U.S. territory with respect to RICs and section 863(b). See the instructions for Forms 1116 and 1118 for these exceptions that apply.

Line 1. Sales. If you file Form 1118, add the amount reported on this line to your other sales and report the total in column 7 of Form 1118, Schedule A, by separate category. See Column (f). Sourced by partner, earlier, for more information.

Line 2. Gross income from performance of services. If you file Form 1118, add the amount reported on this line to your other gross income from performance of services and report the total in column 8 of Form 1118, Schedule A, by separate category.

Lines 3, 4, and 10. Rental income, royalties, and license fees. If you file Form 1118, add the amount reported on these lines to your other rental income, royalties, and license fees and report the total in column 6 of Form 1118, Schedule A, by separate category.

Line 5. Guaranteed payments. If you file Form 1118, add the amount reported on this line to your other guaranteed payments

6 Partner's Instructions for Schedule K-3 (Form 1065) (2025)

and report the total in column 11 of Form 1118, Schedule A, by separate category.

Line 6. Interest income. If you file Form 1118, add the amount reported on this line to your other interest income and report the total in column 5 of Form 1118, Schedule A, by separate category.

Lines 7 and 8. Ordinary dividends and qualified dividends. Some of the amounts reported on these lines may be attributable to PTEP in annual PTEP accounts that you have with respect to a foreign corporation and are therefore excludable from your gross income. If you file Form 1116, don’t include the amount attributable to PTEP in your annual accounts on Part I, line 1a.

If you file Form 1118, add the amount reported on these lines, less the amount attributable to PTEP in your annual PTEP accounts, to your other dividends and report the total in column 4 of Form 1118, Schedule A, by separate category.

See the Instructions for Form 1116 for additional information on the rules regarding capital gain rate differentials (as defined in section 904(b)(3)(D)) for qualified dividends.

Lines 11 through 15 and 27 through 30. Capital gains and losses. Section 904(b)(2)(B) contains rules regarding adjustments to account for capital gain rate differentials (as defined in section 904(b)(3)(D)) for any tax year. These rules apply to individuals and may require adjustments to the amounts on lines 11 through 15, which in turn affect the total amount on line 24. See the Instructions for Form 1116 for additional information. If you file Form 1116, report Schedule K-3, Part II, lines 27 through 30, on Form 1116, Part I, line 5, by separate category.

If you file Form 1118, add the amounts reported on Schedule K-3, Part II, lines 11 through 15, to other gross income you report in column 11 of Form 1118, Schedule A, by separate category. Add the amounts reported on Schedule K-3, Part II, lines 27 through 30, to other amounts you report in column 13(j) of Form 1118, Schedule A; column (e) of Form 1118, Schedule H, Part II; or column (e) of Form 1118, Schedule H, Part III, as applicable, by separate category.

Line 12. Net long-term capital gain. Line 12 doesn’t include gains reported on lines 13, 14, and/or 15.

Line 14. Unrecaptured section 1250 gain. If gain is both unrecaptured section 1250 gain and net section 1231 gain, the gain is reported on line 14 and not on line 15. The partnership included an attachment indicating the amount of unrecaptured section 1250 gain that is also net section 1231 gain.

Line 28. Net long-term capital loss. Line 28 doesn’t include losses reported on line 29.

Lines 16 and 46. Section 986(c) gain and loss. These lines report the partnership’s share of a lower-tier pass-through entity’s section 986(c) gain or loss, and the amount of section 986(c) gain or loss on distributions of PTEP sourced from the partnership’s annual PTEP accounts. You’ll need to determine your foreign currency gain or loss under section 986(c) with respect to distributed PTEP sourced from annual PTEP accounts that you have with respect to a foreign corporation, using Schedule K-3, Part V.

The amount of foreign currency gain and loss that you report on Form 1118 and other forms, for example, Form 1040 or 1120, will include your share of the partnership’s foreign currency gain or loss under section 986(c) and your own foreign currency gain or loss under section 986(c). If you file Form 1118, complete the following.

Add the amount from Schedule K-3, Part II, line 16, to your other section 986(c) gain.
Report the total in column 9 of Form 1118, Schedule A, by separate category.
Identify the type of gain as section 986(c) gain in column 10 of Form 1118, Schedule A.
Add the amount from Schedule K-3, Part II, line 46, to your other section 986(c) losses.
Enter the total, as applicable, by separate category, in:
- Form 1118, Schedule A, column 13(h);
- Form 1118, Schedule H, Part II, column (e); or
- Form 1118, Schedule H, Part III, column (e).

If you entered an amount in column 13(h) of Form 1118, Schedule A, enter the type of loss as section 986(c) loss in column 13(i) of Form 1118, Schedule A.

Lines 17 and 47. Section 987 gain and loss. If you file Form 1118, complete the following.

Add the amount from Schedule K-3, Part II, line 17, to your other section 987 gain.
Enter the total in column 9 of Form 1118, Schedule A, by separate category.
Identify the type of gain as section 987 gain in column 10 of Form 1118, Schedule A.
Add the amount from Schedule K-3, Part II, line 47, to your other section 987 loss.
Enter the total, as applicable, by separate category, in:
- Form 1118, Schedule A, column 13(h);
- Form 1118, Schedule H, Part II, column (e); or
- Form 1118, Schedule H, Part III, column (e).

If you entered an amount in column 13(h) of Form 1118, Schedule A, enter the type of loss as section 987 loss in column 13(i) of Form 1118, Schedule A.

Lines 18 and 48. Section 988 gain and loss. The source of foreign currency gain or loss on section 988 transactions is generally determined by reference to the residence of the taxpayer or QBU on whose books the asset, liability, or item of income or expense is properly reflected. If the source of the foreign currency gain or loss is determined by reference to the residence of the taxpayer, the foreign currency gain and loss will be reported in column (f). For example, if you’re a U.S. resident, such gain or loss is U.S. source and wouldn’t be reported on Form 1116 or 1118. If you file Form 1118, complete the following.

Add the amount from Schedule K-3, Part II, line 18, to your other section 988 gain.
Enter the total in column 9 of Form 1118, Schedule A, by separate category.
Identify the type of gain as section 988 gain in column 10 of Form 1118, Schedule A. See the instructions for column (f).
Add the amount from Schedule K-3, Part II, line 48, to your other section 988 loss.
Enter the total, as applicable, by separate category, in:
- Form 1118, Schedule A, column 13(h);
- Form 1118, Schedule H, Part II, column (e); or
- Form 1118, Schedule H, Part III, column (e).

If you entered an amount in column 13(h) of Form 1118, Schedule A, enter the type of loss as section 988 loss in column 13(i) of Form 1118, Schedule A.

Line 20. Other income. If you file Form 1118, add the amount reported on this line to your other income and report the total in column 11 of Form 1118, Schedule A, by separate category.

Partner's Instructions for Schedule K-3 (Form 1065) (2025) 7

Line 24. Total gross income. If you file Form 1116, add the amounts from lines A, B, and C (and additional lines, if applicable) to your other foreign source gross income from those countries, and enter the totals on Form 1116, Part I, line 1a, taking into account any section 904(b) adjustments for capital gains, as described earlier, for Schedule K-3, Part II, lines 11 through 15, or PTEP adjustments, as described earlier, for Schedule K-3, Part II, lines 7 and 8, and line 16.

If you file Form 1118, add the amounts from lines A, B, and C (and additional lines, if applicable) to your other foreign source gross income from those countries, and enter the totals in column 11 of Form 1118, Schedule A, taking into account any PTEP adjustments, as described earlier, for Schedule K-3, Part II, lines 7 and 8, and line 16.

Section 2—Deductions (Lines 25 Through 54) Form 1118, Schedule A, requires a corporation to separately report certain types of deductions and losses by source and separate category. Separate reporting is required because each type of deduction may be allocated and apportioned according to a different methodology; see Regulations sections 1.861-8 through -20. For purposes of allocating and apportioning expenses, in general, a partner adds the distributive share of the partnership’s deductions with other deductions incurred directly by the partner or through other pass-through entities including partnerships, S corporations, and trusts (see Regulations section 1.904-5(a)(4)(iv) for a definition of pass-through entity); see Regulations section 1.861-8(e)(15). Schedule K-3, Part II, lines 25 through 53, generally follow the separately reported types of deductions and losses on Form 1118, Schedule A. Individuals must generally follow the same expense allocation and apportionment rules, but Form 1116 only requires separate reporting of certain deductions. See Form 1116, Part I, lines 2 through 5.

Line 25. Expenses allocable to sales income. If you file Form 1118, add the amount reported on this line to your other expenses allocable to sales income and report the total in column 13(f) of Form 1118, Schedule A, by separate category.

Line 26. Expenses allocable to gross income from perform- ance of services. If you file Form 1118, add the amount reported on this line to your other expenses allocable to gross income from performance of services and report the total in column 13(g) of Form 1118, Schedule A, by separate category.

Lines 31, 37, 44, and 45. Other deductions. If you file Form 1118, add the amounts reported on these lines to your other deductions and report the total in column 13(j) of Form 1118, Schedule A; column (e) of Form 1118, Schedule H, Part II; or column (e) of Form 1118, Schedule H, Part III, as applicable, by separate category.

Line 32. Research & experimental (R&E) expenses. Add the R&E expenses reported in column (f) to your other R&E expenses. After determining the portion of such expenses that are allocable to U.S. source income or foreign source income because they are performed predominantly in a particular geographic area, if you file Form 1118, report the remaining R&E expenses in Form 1118, Schedule H, Part I. See Regulations section 1.861-17(f).

Lines 33 and 35. Allocable rental, royalty, and licensing ex- penses—depreciation, depletion, and amortization. If you file Form 1118, add the amounts reported on these lines to your other allocable rental, royalty, and licensing expenses (depreciation, depletion, and amortization) and report the total in column 13(d) of Form 1118, Schedule A, by separate category.

Lines 34 and 36. Allocable rental, royalty, and licensing ex- penses—other than depreciation, depletion, and amortiza- tion. If you file Form 1118, add the amounts reported on these

lines to your other allocable rental, royalty, and licensing expenses (other than depreciation, depletion, and amortization) and report the total in column 13(e) of Form 1118, Schedule A, as applicable, by separate category.

Caution: If box 6 of Part I is checked, royalty expenses may include amounts for which you aren’t allowed a deduction under section 267A. See the statement for box 6 of Part I attached to Schedule K-3.

Line 38. Charitable contributions. Charitable contribution deductions shouldn’t be reported on Form 1116 or 1118 because such deductions are allocable to U.S. source income.

Lines 39 and 40. Interest expense specifically allocable un- der Regulations section 1.861-10(e) and Temporary Regu- lations section 1.861-10T. If you file Form 1118, add the amounts reported on these lines to your other interest expense specifically allocable under Regulations section 1.861-10(e) and Temporary Regulations section 1.861-10T and report the total in column (b) of Form 1118, Schedule H, Part II, lines 1b and c.

Lines 41 through 43. Other interest expense. If you file Form 1118, add the sum of the interest expense included on these lines to your other interest expense and report the total in column (b) of Form 1118, Schedule H, Part II, line 2.

If you file Form 1116, allocate and apportion the sum of the interest expense included on these lines and report the allocated and apportioned amounts on the applicable separate category Form 1116, Part I, line 4b. Interest expense incurred by certain individuals, estates, and trusts is allocated and apportioned based on the categories of interest expense in sections 163 and 469, adjusted for any interest expense directly allocated under Temporary Regulations section 1.861-10T. See Regulations section 1.861-9(e)(3) and Temporary Regulations sections 1.861-9T(d)(1) and (3). Exception. If you’re a limited partner, and your ownership, together with ownership by persons that bear a relationship to the partner described in section 267(b) or section 707, of the capital and profits interest of the partnership is less than 10%, your distributive share of the partnership’s interest expense generally reduces passive category foreign source gross income. See Regulations sections 1.861-9(e)(4)(i) and 1.904-4(n)(1)(ii) for further guidance. If you file Form 1118, report interest expense from such limited partners on the passive category column 13(j) of Form 1118, Schedule A, unless the high-taxed income exception of section 904(d)(2)(B)(iii)(II) is applicable. If you file Form 1116, report such interest expense on the passive category Form 1116, Part I, line 4b, unless the high-taxed income exception of section 904(d)(2)(B)(iii)(II) is applicable. However, if your partnership interest is held in the ordinary course of your active trade or business, your share of the partnership’s interest expense is apportioned in accordance with your share of gross foreign source income in each separate category and gross U.S. source income from the partnership. Report the interest expense on the appropriate Form 1116 or 1118, as applicable. Exception. See Regulations sections 1.861-9(e)(8) and (9) for special rules concerning downstream and upstream partnership loans that require a matching of related interest income to interest expense allocations.

Caution: If box 6 of Part I is checked, interest expense may include amounts for which you aren’t allowed a deduction under section 267A. See the statement for box 6 of Part I attached to Schedule K-3.

Exception. See Temporary Regulations section 1.861-9T(d) (1) for an exception to the apportionment of interest expense when an individual’s foreign source income (including income excluded under section 911) doesn’t exceed $5,000. Such

8 Partner's Instructions for Schedule K-3 (Form 1065) (2025)

interest expense may be allocated entirely to U.S. source income.

Line 45. Foreign taxes not creditable but deductible. See the instructions for Forms 1116 and 1118 for examples of foreign taxes not creditable but deductible.

Note: Foreign taxes that are creditable (even if a partner chooses to deduct such taxes) aren’t reported as expenses on Part II. Don’t claim a foreign tax credit on Form 1116 or 1118 for amounts reported on line 45. However, you may claim a deduction for such taxes on the applicable form, including Forms 1040 and 1120. Creditable foreign taxes are reported on Part III, Section 4.

Line 49. Other allocable deductions. If you file Form 1118, add the amounts reported on this line to your other allocable deductions and enter the total in column 13(j) of Form 1118, Schedule A, by separate category.

Line 50. Other apportioned share of deductions. If you file Form 1118, add the amounts reported on this line to your other apportioned share of deductions and report the total in column (e) of Form 1118, Schedule H, Part II; or column (e) of Form 1118, Schedule H, Part III, by separate category.