U.S. Partnerships With Foreign Partners
Withholding of Tax
Where a US partnership (or a US LLC taxed as a partnership) has taxable income that is considered effectively connected with the conduct of a trade or business within the United States (“effectively connected income”, or “ECI”) and also has partners that are non-citizens, non-residents (“Foreign Partner”), the partnership must report and pay a withholding tax under IRC Section 1446 to the US Internal Revenue Service (IRS). A Foreign Partner also includes a foreign corporation, foreign partnership, foreign trust, foreign estate, and any other person that is not a US person.
The withholding rules are very strict. The partnership must pay the withholding tax regardless of the amount of the foreign partners’ ultimate US tax liability. Thus, it could be that the foreign partner will actually owe no US tax, but the partnership must nonetheless withhold and pay over to the IRS. The affected foreign partner must file a tax return with the IRS and claim a refund. Furthermore, the withholding rules apply regardless of whether the partnership makes any actual partnership distributions during its tax year.
The rate of withholding will depend on the status of the partner and the type of income earned by the partnership. Withholding is imposed at the highest tax rate of 39.6% for noncorporate foreign partners; a 20% rate is imposed for individual long-term capital gain, and at a 35% rate for foreign corporate partners. Overwithholding is a very common result due to the high withholding rates.
Revenue Procedure 92-66, and Treasury Regulation section 1.1446-3 set forth the time and manner for the partnership to pay the withholding tax, as well as the general reporting obligations with respect to the tax. Refer to Form 8804, Annual Return for Partnership Withholding Tax (Section 1446), Form 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax, and Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446), for further guidance on reporting and paying the IRC section 1446 withholding tax. A partnership that fails to comply with IRC section 1446 reporting and withholding requirements may be subject to penalties and interest.
US TIN is Very Important – Claiming a Refund for Overwithheld Tax
In order for a foreign partner to claim a refund of overwithheld tax, a valid Taxpayer Identification Number (TIN) is required. In order to claim the refund, a foreign partner must file an income tax return (Form 1040NR, Form 1120F, etc.) with a valid TIN. Even if a foreign partner does not have a TIN, the partnership must still pay the withholding tax for that foreign partner. Thus, the partner can lose out on a tax refund if he lacks a TIN.
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 US employer identification number (EIN).
Foreign partners will annually be provided a Form 8805, “Foreign Partner’s Information Statement of Section 1446 Withholding Tax”, by the partnership. Form 8805 will show the amount of ECI and the total tax credit allocable to the foreign partner for the partnership’s tax year. The foreign partner must attach Form 8805 to their US income tax returns to claim a credit for their share of the IRC section 1446 tax withheld by the partnership. To insure proper crediting of the withholding tax when reporting to the IRS, a partnership must provide a TIN for each foreign partner. The partnership should notify any of its foreign partners without a valid TIN of the necessity of obtaining a US taxpayer identification number.