Partnerships have many filing and reporting requirements. In addition to being required to file annual partnership tax returns (Form 1065), a partnership with foreign partners could be responsible for other tax issues such as:
- Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”);
- NRA Withholding; and
- Partnership Withholding.
I have discussed FIRPTA and NRA withholdings in previous articles, so the goal of this article is to discuss the partnership withholding requirements. This is a very misunderstood area of the law and can sometimes be difficult to explain to clients, especially since they reside overseas. Let’s take a closer look at the requirements.
What is a partnership withholding on foreign partners and why is it required?
If a partnership (including an LLC filing as a partnership) has income that is effectively connected with a U.S. trade or business, it is required to withhold on the income that is allocated to its foreign partners. This withholding is required under IRC section 1446. Revenue Procedure 92-66 and Treasury Regulation section 1.1446-3 establish the timing and reporting requirements of the withholding tax.
This withholding tax requirement does not apply to income that is not effectively connected with the partnership’s U.S. trade or business. The goal of course is to ensure that the IRS collects tax from nonresident aliens in case they fail to file a tax return and, accordingly, pay any tax that is due.
What are the withholding rates?
The withholding rate that is applicable for effectively connected income allocable to non-corporate foreign partners is 39.6%. However, the rate is 35% for corporate foreign partners.
Are there any exceptions or exclusions?
The IRS allows foreign partners to certify to the partnership certain deductions and losses that will be applicable to the current year. In addition, a nonresident alien partner can also certify to the partnership that the partnership investment is (and will be) the only activity of the partner for the partner’s taxable year that gives rise to effectively connected income, gain, loss or deduction.
In the case of a partner certification, the partnership is not required to withhold and pay a withholding tax with respect to the foreign partner if the partnership estimates that the annualized or actual tax due is less than $1,000.
What forms does the partnership file to report the tax?
The withholding tax liability of the partnership for its tax year is reported on Form 8804. A Form 8805 for each foreign partner must be attached to Form 8804, whether or not any withholding tax was paid.
File Form 8804 by the 15th day of the 4th month after the close of the partnership’s tax year. However, a partnership made up of all nonresident alien partners has until the 15th day of the 6th month after the close of the partnership’s tax year to file. File Forms 8804 and 8805 separately from Form 1065. If a due date falls on a Saturday, Sunday, or legal holiday, file by the next business day.
If you need more time to file Form 8804, you may file Form 7004 to request an extension. But realize that Form 7004 is merely an extension and does not extend the time to pay the tax.
What forms does the partnership use to remit the tax?
Payment of the tax is done using another form. The partnership must use Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446), to pay quarterly installments of withholding tax to the IRS. A Form 8813 must accompany each payment of tax made during the partnership’s tax year.
It is important to note that the partnership must pay the withholding tax regardless of the amount of the foreign partners’ ultimate U.S. tax liability (which is often dependent on other taxable income) and regardless of whether or not the partnership makes any cash distributions during its tax year to the partners.
When is the tax required to be remitted?
Form 8813 should be filed on or before the 15th day of the 4th, 6th, 9th, and 12th months of the partnership’s tax year for U.S. income tax purposes.
To insure proper crediting of the withholding tax when reporting to the IRS, a partnership must provide a U.S. taxpayer identification number (TIN) for each foreign partner. The partnership should notify any of its foreign partners without a valid TIN of the necessity of obtaining a U.S. taxpayer identification number. An individual’s taxpayer identification number is the individual’s social security number (SSN) or individual taxpayer identification number (ITIN). An ITIN will always begin with a 9, and the middle two digits will be in the range of 70 to 80. It is also possible that a partner’s TIN could be its U.S. employer identification number (EIN).
What are the requirements of foreign partners?
A foreign partner is required by law to file a U.S. income tax return even if there is no U.S. tax due. A valid ITIN (taxpayer id #) is required. Foreign partners must also attach Form 8805 to their U.S. individual tax returns in order to claim a credit for their share of the tax that was withheld by the partnership.
What about tax treaties?
The US has entered into tax treaties with many countries that can reduce the withholding requirement. Make sure to verify the requirements against a tax treaty.