Section 2. Lines 25 Through 54. Total Deductions

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, for example, Regulations sections 1.861-8 through -20 and Temporary Regulations sections 1.861-8T and -9T. For purposes of allocating and apportioning expenses, in general, a partner adds the distributive share of the partnership’s deductions to its other deductions incurred directly by the partner. See Regulations section 1.861-8(e)(15). Generally, Section 2 follows 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 by separate category. See Form 1116, Part I, lines 2 through 5. Generally, Section 2 also corresponds to the deductions separately reported on Form 8865, Schedule K.

Line 32. R&E expenses. In general, R&E expenses are allocated and apportioned by the partner and reported in column (f). See Regulations section 1.861-17(f). R&E expenses, as described in section 174, are ordinarily definitely related to gross intangible income reasonably connected with relevant broad product categories of the taxpayer and are allocable to gross intangible income as a class related to such product categories. The product categories are determined by reference to the three-digit classification of the Standard Industrial Classification Manual (SIC code) .

Line 38. Charitable contributions. Charitable contribution deductions are apportioned solely to U.S. source gross income. See Regulations section 1.861-8(e)(12). So, this deduction should be reported in column (a).

Inst. for Schedules K-2 and K-3 (Form 8865) (2025) 9

Lines 39 and 40. Interest expense specifically allocable un- der Regulations section 1.861-10 and Temporary Regula- tions section 1.861-10T. Apart from interest expense entered on line 39, enter on line 40 interest expense that is directly allocable under Temporary Regulations section 1.861-10T to income from specific partnership property. Such interest expense is treated as directly allocable to income generated by such partnership property. See Temporary Regulations section 1.861-9T(e)(1).

Lines 41 through 43. Other interest expense. A partner’s distributive share of a partnership’s interest expense that isn’t directly allocable to income from specific partnership property is generally allocated and apportioned by the partner, subject to certain exceptions, and included in column (f). See Temporary Regulations section 1.861-9T(e)(1).

Interest expense incurred by certain individuals, estates, and trusts is characterized based on the categories of interest expense in sections 163 and 469: active trade or business interest, investment interest, or passive activity interest, adjusted for any interest expense directly allocated under Temporary Regulations section 1.861-10T. See Temporary Regulations section 1.861-9T(d). The amounts in each category of interest expense are reported on lines 41 through 43. See the Partnership Instructions for Schedules K-2 and K-3 (Form 1065) for an example. Also see the Partnership Instructions for Schedules K-2 and K-3 (Form 1065) for instances when interest expense may reduce passive category income or income in other categories and an attachment may be necessary. If the partnership’s only partners are corporate partners, don’t report the partnership’s interest expense by the categories of interest expense in sections 163 and 469. All such interest expense may be reported as business interest expense on line 41.

Exception. See Regulations sections 1.861-9(e)(8) and (9) for a special rule for partnership loans. See also the instructions for box 10 of Part I.

Note: Interest expense is always included on lines 39 through 43 and not on other lines.

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

Note: Foreign taxes that are creditable (even if a partner chooses to deduct such taxes) aren’t reported as expenses in Part II. Creditable taxes are reported in Part III, Section 4.

Lines 49 and 50. Other deductions. Attach to the Schedules K-2 and K-3 a statement describing the amount and type of other deductions. The statement must conform to the format of Part II.

Schedule K-2, Part III; and Schedule K-3, Part III (Other Information for Preparation of Form 1116 or 1118)