Withholding Requirements for Partnerships with Foreign Partners

On May 13, 2005, the IRS issued final and temporary regulations under Sec. 1446 (TD 9200), which contain new rules affecting the withholding requirements for partnerships with foreign partners.

Final Regs.

The final regulations provide guidance for partnerships required to pay withholding tax under Sec. 1446. They permit a partnership to consider the character of income or gain allocable to a foreign partner in applying the highest rate applicable to that type of income or gain. For example, to the extent that long-term capital gain is allocable to a noncorporate foreign partner, a partnership may withhold tax by using the highest capital gain rate (currently, 15%). Also, the final regulations prohibit a partnership from using a preferential rate in computing the Sec. 1446 tax on income or gain allocable to a foreign partner if such rate depends on whether the partners status is corporate or noncorporate, and if either the (1) status was not documented or (2) regulations require withholding at the highest applicable Sec. 1446(b) rate. 

The final regulations clarify that a domestic upper-tier partnership (UTP) may elect to have the Regs. Sec. 1.1446-5 lookthrough rules apply, permitting a lower-tier partnership (LTP) to look through the UTP.  The LTP is required to consent in writing to this election.

The final regulations also (1) relax the notice requirements for partnerships with 500 or more foreign partners, (2) clarify when a partnership will be deemed to have paid Sec. 1446 tax under the deemed-payment rule, (3) contain special rules for domestic and foreign estates and trusts and (4) fine-tune many provisions in the 2003 proposed regulations (REG-108524-00, 9/2/03).

Temp. Regs.

The temporary regulations permit certain foreign partners to certify deductions and losses to a partnership, to reduce the Sec. 1446 tax the partnership has to withhold on their allocable effectively connected income (ECI). A foreign partner choosing to certify its losses and deductions must submit a new certificate for each partnership tax year. A foreign partner can only submit a certificate if it has submitted documentation to the partnership establishing that:

1. It is in compliance with Regs. Sec. 1.1446-1;

2. It filed or will timely file U.S. income tax returns for each of the preceding four tax years and for the tax year for which it filed the certificate; and

3. The tax corresponding to these filings was or will be timely paid.

Certificates must be submitted to the partnership at least 30 days before the partnership installment due date or the filing date (without extensions) of Form 8804, Annual Return for Partnership Withholding Tax (Section 1446), for the applicable partnership tax year. Further, the certificate must identify the character of any certified deductions or losses, as well as the special characteristics they may carry, such as passive activity or suspended losses.

Background Information to Be Submitted

A U.S. partnership pays Sec. 1446 tax by submitting Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446), on or before the 15th day of the 4th, 6th, 9th and 12th months of the partnerships tax year. After the partnership tax year closes, the partnership has to file Forms 8804 and 8805, Foreign Partners Information Statement of Section 1446 Withholding Tax, and provide Form 8805 to each foreign partner. Each foreign partner that receives this form can generally claim a credit under Sec. 33 on its Federal income tax return, in the amount shown on the form as paid on the partners behalf.

In completing Forms 8804 and 8805, the partnership uses the actual results of its operations for the previous year. It pays any shortfall when filing Form 8804 if it determines that the Sec. 1446 tax is greater than it previously estimated.

Form Revisions

The IRS intends to modify several forms (e.g., W-8 series, 8804, 8805 and 8813) to accommodate the final and temporary regulations. However, until these forms are revised, the current versions should be used with a statement attached explaining how the form is being used for Sec. 1446 purposes.

Effective Date

These regulations are effective for partnership tax years beginning after May 18, 2005. However, a partnership may elect to apply the final regulations to partnership tax years beginning after 2004. A partnership may also elect to apply the temporary regulations to partnership tax years beginning after 2004, provided it also elects to apply the final regulations to those same years.

From Sadia Nazir, CPA, Oak Brook, IL