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U.S. Partnerships with Foreign Partners |
Withholding on Income Allocable to Foreign Partners
Last Updated June 9, 2005
Tax Payments
U.S. resident individuals and U.S. corporations are generally required to make quarterly estimated tax payments on their business income. U.S. partnerships typically do not need to make quarterly estimated payments because the partnership earnings flow thru, and are taxable to, the partners. If the partners are U.S. resident individuals or U.S. corporations, then all of the necessary estimated payments are made.
Congress was concerned that foreign partners in U.S. partnerships might not pay taxes to the U.S. Treasury, even though they are subject to U.S. income tax on their proportionate share of the U.S. partnership’s income. Therefore, Congress enacted section 1446 which requires that the U.S. partnership make tax payments on behalf of the foreign partners.
Domestic / Foreign Status of Partners
In order to determine whether a U.S. partnership needs to withhold tax under section 1446, the partnership must identify its partners as either U.S. persons or foreign persons. In addition, if the partner is a foreign person, then the partnership must know whether the partner is a corporation.
There are several different forms that a partner can use to identify themselves as either domestic or foreign persons. The most common forms include W-9 for domestic persons and W-8BEN for foreign persons. Although the partnership is permitted to use other means to ascertain non-foreign status, a partnership must generally presume that a partner is a foreign person if the partner does not furnish information regarding its domestic or foreign status.
Withholding Rates
A U.S. partnership with foreign partners generally must pay a withholding tax on partnership taxable income allocable to the foreign partners. The withholding tax rate is equal to the highest rate of tax specified in section 1 [with respect to non-corporate foreign partners] and section 11(b)(1) [with respect to corporate foreign partners]. The highest rate listed in both of these sections is currently 35%.
However, the partnership can generally choose to pay using the highest applicable tax rate for certain preferential items allocated to non-corporate partners, such as capital gains (currently 15%), collectible gains (currently 28%), and unrecaptured section 1250 gain (currently 25%).
Deemed Distributions
The partnership's payment of the withholding tax is treated as a cash distribution to each applicable foreign partner. The rationale behind this rule is that the partnership has incurred a cost that truly should be borne by the partner. Thus, it is equivalent to the partnership making a cash distribution to the partner and the partner making the payment. The only difference is that the U.S. Treasury is more likely to collect its revenue with the partnership making the payment.
Partnership Forms to be Filed
The partnership must make quarterly estimated payments on Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446). After the close of the partnership’s taxable year, the partnership must pay any additional section 1446 taxes due when it files Form 8804, Annual Return for Partnership Withholding Tax (Section 1446). The partnership must also provide Form 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax, to each foreign partner.
Partner Forms to be Filed
Nonresident alien individuals should file Form 1040NR, U.S. Nonresident Alien Income Tax Return to claim any refund they may be due. Foreign corporations should file Form 1120F, U.S. Income Tax Return of a Foreign Corporation to claim any refund that may be due.
Other Complexities
The above overview is exactly that – an overview. There are numerous other complexities related to U.S. partnerships with foreign partners. A few of these complexities include:
- Interplay with section 1445 (Withholding on Dispositions of U.S. Real Property Interests),
- Interplay with sections 1441 & 1442 (Withholding on non-effectively connected income of Nonresident Aliens and Foreign Corporations),
- Interplay with sections 871(d) and 882(d) (Elections to Treat Real Property Income as Income Connected with U.S. Business),
- Withholding related to tiered partnerships, and
- Nonresident alien individuals may be subject to U.S. estate taxes.
While the discussion above refers solely to U.S. partnerships, section 1446 also applies to foreign partnerships with U.S. effectively connected income.
