Foreign Partner Withholding for the U.S. Partnership
We introduce the general rules and withholding responsibility for the United States trade or business operating as a partnership with one or more foreign partners.
By “foreign partners,” we generally mean nonresident aliens and foreign corporations. The term can also mean foreign partnerships with a U.S. business connection through a U.S. partnership, but this is not our focus.
If you are a U.S. partnership and add a foreign owner, you have new responsibilities as a qualified intermediary or withholding agent as to the foreign partner’s share.
Our focus amounts subject to withholding when the foreign person invests in a U.S. partnership with a business. It isn’t the foreign investor in listed stocks on a U.S. exchange or the foreign investor in a U.S. bank’s certificate of deposit. Investing in U.S. real estate is not our emphasis.
Foreign person introduces new tax requirements
Under our internal revenue code, a tax partnership may operate under a partnership or LLC agreement. A partnership trade or business in our country files the usual Form 1065 partnership return even if it has one or more foreign partners.
Foreign partners as beneficial owners introduce some special rules the professional will need to understand. See Helpful Hints for Partnerships with Foreign Partners.
Withholding tax
There are exemptions from withholding. See Withholding Exemption on Effectively Connected Income. But the general rule looks to withholding for foreign partners and their K-1 distributive shares of U.S. partnership income.
Get prepared to withhold U.S. tax, possibly state tax too, if you are a U.S. partnership with a foreign partner. Withholding can be required even without distributions. Measuring withholding can depend on such factors as whether the partner is a corporation or an individual.
Plan for sufficient partnership cash to send withholding to the IRS.
Our topic is largely governed by section 1446, “Withholding of tax on foreign partners’ share of effectively connected income.” The usual U.S. rules govern a foreign partner’s distributive share. See Sec. 704 cited in Sec. 1446(a)(2).
The main tax forms include:
- Form 1065, U. S. Return of Partnership Income;
- Form 1040-NR, U.S. Nonresident Alien Income Tax Return;
- Form 1120-F, U.S. Income Tax Return of a Foreign Corporation;
- Form 8804, Annual Return of Partnership Withholding Tax (Section 1446);
- Form 8805, Foreign Partner’s information Statement of Section 1446 Withholding Tax;
- Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446).
The amounts withheld on Form 8804 should match the amounts on Forms 8805, which is filed by the partnership and provided to foreign partners.
The basic idea is that foreign partners attach Form 8805 to their U.S. return. This way they get credit for the withheld tax. It is possible to have tax allocable to you withheld, and you never get the benefit because you didn’t file or don’t file correctly.
A trade or business in the United States
There are some adjustments but our focus is “taxable income of the partnership which is effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States…” See “Partnership Withholding,” and Sec. 1446(c).
The following comment from an IRS website introduces the foreign partner to the concept of being engaged in a U.S. trade or business because of membership in the partnership so engaged:
“If you are a member of a partnership that at any time during the tax year is engaged in a trade or business in the United States, you are considered to be engaged in a trade or business in the United States.” Effectively Connected Income (ECI).
Withholding on undistributed share of income
Corporations pay their own tax, whereas partnerships are flow-through, tax-reporting entities. We refer to C corporations, not S corporations which aren’t permitted to have nonresident alien shareholders. Section 1361(b)(1)(C).
Because of the flow-through concept for partnership income, a partner, including a foreign partner, can have taxable income reportable in the U.S. even though there are no entity distributions to help pay the partner’s tax.
We introduce this background to emphasize an important and often surprising aspect of the rules. The withholding concept is on a foreign partner’s share partnership business income, not partnership distributions.
So the foreign partner (like a U.S. partner) can have taxable income without receiving distributions from the partnership. As to the foreign partner, the partnership can end up withholding without making distributions to the foreign partner.
It is important to understand when an individual partner is a nonresident alien. A nonresident alien might even have a U.S. address, or be a nonresident alien for part of the year. See Topic No. 851, Resident and Nonresident Aliens.
More forms
See also Form W-8BEN (Rev October 2021) Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals). Form W-8BEN can serve as documentation that could potentially reduce the withholding tax. Entities use Form W-8BEN-E.
See also About Form 1042-S “Foreign Person’s U.S. Source Income Subject to Withholding,” and 1042-T “Annual Summary and Transmittal of Forms 1042-S.”
Normal deadlines may have at times been delayed by the coronavirus pandemic. See “About Form 8804, Annual Return of Partnership Withholding Tax (Section 1446).”
One of the possible complications here is “tiers of partnerships.” See Instructions for Forms 8804, 8805, and 8813 (2021).
Calculating Withholding
Regulations 1.1446-3 have details as to calculating the withholding in installments – withholding isn’t just an end-of-the-year, filing-time problem.
The approach considers the type of income but assumes the maximum tax rate. Whether you are a foreign corporation or foreign individual affects the withholding. Another important resource within these rules is IRS Revenue Procedure 92-66.
Can the U.S. partnership reduce the tax withholding for estimated taxes the partner is paying as a corporation or individual? No. See. Regs. 1.1446-3(b)(2)(iii).
There are withholding issues here that have to be coordinated with the withholding rules with other circumstances, other types of income. See Regs. 1.1446-3(c).
Special rules
Our topic is filled with many detailed rules.
Special rules can apply to publicly traded partnerships.
Special rules can apply when a foreign person sells or exchanges an interest in a partnership (foreign or domestic) which is engaged in a trade or business within the United States.
The 2017 Tax Cuts and Jobs Act created a withholding tax on amounts realized by a foreign person’s sale, exchange or other disposing of a partnership interest when the foreign person could have income effectively connected to a U.S. business if the partnership sold its assets. See IRS Notice 2021-51, Sec. 864(c)’(8), 1446(f). See Instructions for Forms 8804, 8805, and 8813.
Treaties
The tax professional needs to add this to the tax research list – remember to include a review of the U.S. treaty with the foreign country. Treaties may modify the general rules governing such topics as income tax withholding.
It really is complicated
The issues and the math when you have foreign partner withholding in your U.S. partnership will generally require some professional analysis. We can help with this complicated topic.
Keep in mind that just having a foreign partner can introduce withholding even without distributions to the foreign partner. The partnership with foreign partners tax requirements means unique partnership tax filing.