U.S. Tax Withholding on Effectively Connected Income Allocable to Foreign Partners
International Tax Gap Series
IRS reminds all partnerships engaged in a U.S. trade or business who have foreign partners that IRC section 875(1) treats each foreign partner as being directly engaged in the same trade or business for U.S. federal tax purposes. Additionally, IRC Section 1446 imposes a partnership-level withholding tax (1446 tax) for each foreign partner's allocable share of the partnership’s effectively connected taxable income. The foreign partner, considered engaged in a U.S. trade or business, must also file the appropriate income tax return with the U.S.
This article, the eighth in a series relating to the international tax gap, explains the rules for proper 1446 tax withholding and information reporting of effectively connected taxable income allocable to foreign partners of domestic or foreign partnerships.
In general, if a domestic or foreign partnership has effectively connected taxable income (ECTI) that is allocable to a foreign partner, then the partnership must withhold the proper amount of tax, and file Form 8804, reporting the total 1446 tax required to be withheld and paid, and Form(s) 8805, reporting the payment attributable to each foreign partner on whose behalf the tax was withheld, by the 15th day of the 4th month after the close of the partnership’s tax year. Partnerships that keep their books and records outside the United States and Puerto Rico must file these forms by the 15th day of the 6th month after the close of the partnership’s tax year. Also, the 1446 tax must be paid in installments on the 15th day of the 4th, 6th, 9th, and 12th month of the partnership’s year by filing Form 8813.
In addition to the general requirement above to withhold under Section 1446, U.S. source income that is not effectively connected with the partnership's U. S. trade or business may be subject to withholding as required under IRC Sections 1441, 1442, 1443. Report this type of withholding on Form 1042 and Form(s) 1042-S. Refer to Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities, and to the Instructions for Form 1042-S.
The partnership (or a withholding agent for the partnership) is responsible for the withholding and reporting requirements. Also, the partnership is responsible for determining if the partner is a foreign partner. The foreign partner may be a nonresident alien individual, foreign partnership, foreign corporation, foreign estate or foreign trust.
A partner is presumed foreign unless the partnership obtains the appropriate documentation (Form W-9 or appropriate Form W-8) from the partner or relies on other means to ascertain the non-foreign status of the partner and the partnership is correct in its determination. The partnership must keep the documentation (Form W-8) for as long as it is relevant to the partnership’s withholding tax liability.
A partnership (withholding agent) must notify each partner of the tax withheld on the partner’s behalf within 10 days of the installment due date, or, if paid later, the date the installment payment is made. A withholding agent who fails to withhold and report ECTI allocable to foreign partners is subject to penalties and interest. The withholding agent may be held liable for any tax required to be withheld, independent of the tax liability of the foreign partner for whom the 1446 tax is paid.
Graduated 1446 Tax Withholding Rates
The withholding tax rate on ECTI allocable to a foreign partner is currently 35% on net ordinary income; 28% on gains for non-corporate partners; 25% on unrecaptured section 1250 gains for non-corporate partners; and 15% on qualified dividend income and NLTCG (including net section 1231 gains) allocable to non-corporate partners.
Application for Reduced Withholding by the Foreign Partner
A foreign partner that meets certain requirements may be eligible to certify to the partnership certain of the partner’s deductions or losses or that its interest in the partnership is the only activity that gives rise to effectively connected income. The partnership may consider this certification to reduce or eliminate the partnership's 1446 tax on the partner's allocable share of ECTI from the partnership. Form 8804-C is used by a foreign partner who chooses to provide to a partnership a certification under regulations section 1.1446-6. Refer to Form 8804-C Instructions for more information.
Additional References and Links
For more information on withholding involving payments to foreign persons, see Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.
Also refer to Helpful Hints for Partnerships with Foreign Partners; Non Resident Alien Withholding; and, IRB 2004-7 for additional information on this topic.
The International Tax Gap Series