U.S. Partnerships With Foreign Partners.

Related: #US Tax, #Partnerships, #Form 1042, Form 1042-S, #Taxpayer Identification Number (TIN), #Form 8804, #Form 8805

To ensure compliance with requirements imposed by the IRS, we inform you that, unless specifically indicated otherwise, any tax advice contained in this communication (including any attachments) was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any tax-related matter addressed herein.

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.

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.

This withholding tax regime under IRC section 1446 does not apply to income that is not effectively connected with the partnership's U.S. trade or business (i.e., it does not apply to FDAP income). FDAP income is subject to the NRA withholding tax regime, Forms 1042/1042-S, under which withholding is required under Internal Revenue Code Chapter 3 sections 1441, 1442, and 1443. This withholding tax regime requires 30% withholding on a payment of U.S. source income to a foreign person.

What are the withholding rates?

Withholding Tax on Foreign Partners' Share of Effectively Connected Income – IRC Section 1446.

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.

New tax rates for 2018. For tax years beginning after December 31, 2017, and before January 1, 2026, the maximum tax rate for non-corporate foreign partners has decreased from 39.6% to 37%. For tax years beginning after December 31, 2017, the maximum tax rate for corporate foreign partners has decreased from 35% to 21%.

A partnership (foreign or domestic) that has income effectively connected with a U.S. trade or business (or income treated as effectively connected) must pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners.

Are there any exceptions or exclusions?

Treasury Regulation section 1.1446-6 allows foreign partners to certify to the partnership prior year deductions and losses that carry over to the current year.  Under these regulations a nonresident alien partner is also permitted to 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, deduction, or loss.  In that case, the partnership is not required to pay IRC section 1446 tax with respect to the foreign partner if the partnership estimates that the annualized or actual IRC section 1446 tax due is less than $1,000.

If a nonresident alien partner's investment in the partnership is the only activity producing effectively connected income and the IRC section 1446 tax is less than $1,000, the partnership is not required to withhold. For information on the certification in this situation, see section 1.1446-6T(c)(1)(iv) of the regulations.

A foreign partner is required to file a U.S. income tax return even if there is no U.S. tax due. A valid Taxpayer Identification Number (TIN) is required.

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.

Generally, file these forms on or before the 15th day of the 3rd month following the close of the partnership's tax year. For partnerships that keep their records and books of account outside the United States and Puerto Rico, the due date is the 15th day of the 6th month following the close of the partnership's tax year. If the partnership is permitted to file these forms on or before the 15th day of the 6th month, check the box at the top of Form 8804.

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. 

Note. Filing a Form 7004 doesn't extend the time for payment of 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.

Late Filing of Form 8804

A partnership that fails to file Form 8804 when due (including extensions of time to file) generally can be subject to a penalty of 5% (0.05) of the unpaid tax for each month or part of a month the return is late, up to a maximum of 25% (0.25) of the unpaid tax. The penalty won't apply if the partnership can show reasonable cause for filing late.

If Form 8804 is filed more than 60 days late, the minimum penalty will be $210, or the amount of any tax owed, whichever is smaller.

If you receive a notice about penalty and interest after you file Form 8804, send us (IRS) an explanation and we will determine if you meet reasonable-cause criteria. Don't attach an explanation when you file Form 8804.

Late Payment of Tax

The penalty for not paying tax when due is usually 1 2 of 1% (0.005) of the unpaid tax for each month or part of a month the tax is unpaid. The penalty can’t exceed 25% (0.25) of the unpaid tax. The penalty won't apply if the partnership can show reasonable cause for paying late.

If you receive a notice about penalty and interest after you file Form 8804, send us (IRS) an explanation and we will determine if you meet reasonable-cause criteria. Don't attach an explanation when you file Form 8804.