In addition, this new withholding is required in all partnership interest purchases unless a specific exception applies.
Sec. 864(c)(8), which was enacted as part of the Tax Cuts and Jobs Act (TCJA), treats a portion of the gain on the disposal of a partnership interest by a nonresident partner as income effectively connected with the conduct of a U.S. trade or business (ECI); thus making it taxable in the United States. In these cases, the ECI amount is determined through a hypothetical sale of the partnership’s assets at fair market value as of the date of the nonresident partner’s disposition. The partner’s distributive share of this hypothetical gain’s ECI is then applied to the partner’s gain on the disposition of their partnership interest to determine the amount of taxable gain on the sale.
The TCJA also enacted Sec. 1446(f), which institutes a 10 percent withholding requirement on the disposition of partnership interest by a foreign partner. Any tax withheld is creditable to the foreign partner’s U.S. income tax liability under Sec. 864(c)(8), and any excess amount is refunded to the extent the amount withheld exceeds the actual tax liability.
Six exceptions from withholding and reduction of amount to withhold
The proposed regulations provide six exceptions from the required 10 percent withholding:
- The partner disposing of the partnership interest certifies under penalty of perjury that they are a U.S. resident at the time of disposition.
- There is no taxable gain realized by the partner during the disposition of the partnership interest.
- The partnership is able to certify that, if under a hypothetical sale of all its assets at fair market value as of the “determination date,” no part of the hypothetical gain is considered ECI.
- The partner certifies the gain on disposition of partnership interest qualifies for nonrecognition under certain provisions of the Internal Revenue Code.
- The partner certifies the gain on disposition isn’t subject to tax under a relevant tax treaty between the United States and the foreign jurisdiction; or
- (a) The partner was a partner of the partnership for at least the prior three taxable years; (b) the partner’s share of effectively connected taxable income (ECTI) allocated from the partnership during the aforementioned tax years didn’t exceed $1 million in any year; (c) the percentage of partnership income that was ECTI was less than 10 percent of total partnership taxable income in each of the prior three taxable years; and (d) that all U.S. tax returns for the past three years were properly filed with IRS and that the partner paid any related income tax.
Purchasers are also allowed to withhold less than the required 10 percent in situations where the amount required to be withheld exceeds the amount of the seller’s tax liability related to the transaction, and certain documentation requirements are met. Note that in cases where the purchaser of the partnership interest fails to properly withhold, the partnership is required to withhold on any subsequent distributions made to the purchasing partner until the withholding liability is satisfied.
If FIRPTA withholding also applies to the disposition of a partnership interest, then the withholding set by Sect. 1446(f) will not apply. However, if FIRPTA applies but the taxpayer is able to avoid the withholding tax via a withholding certificate under Regulation Sec. 1.1445-2, then Sec. 1446(f) withholding tax may still apply.
An important consideration for all acquirers of a partnership interest, is that absent an exemption, such as a certification that a transferor is a U.S. person, the acquirer of the interest has an obligation to withhold.
To navigate these exceptions, and to better understand when the new withholding requirements are applicable, all purchasers should request Form W-9 from the selling partners.
To navigate these exceptions, and to better understand when the new withholding requirements are applicable, all purchasers should request Form W-9 from the selling partners; if the partnership doesn’t already have them on file.
Additional required compliance reporting and timing
The amount required to be withheld under Sec. 1446(f) must be calculated on the determination date, as defined by Regulation Sec. 1.1446(f)-1(c)(4). This date can generally be one of the following:
- The date of transfer
- Any date 60 days leading up to the transfer
- The later of either:
- The first day of the partnership’s taxable year in which the transfer occurs
- The date of the most recent revaluation event before the transfer
Additional guidance relating to the reporting requirements of the Sec. 1446(f) withholding tax is provided in Notice 2018-29, and is summarized as follows:
- The partner must notify the partnership of the sale of a partnership interest within 30 days of the exchange. The notification must include the names, addresses, and taxpayer identification numbers of the parties involved, as well as the date of the exchange.
- The purchaser must complete and file Forms 8288 and 8288-A, and include the statement “Section 1446(f)(1) withholding” at the top of both forms. These forms are due to the IRS on the 20th day after the date of transfer.
- Certifications of the aforementioned exceptions to Sec. 1446(f) must be provided by the partners to the purchaser or the partnership because it makes a distribution no earlier than 30 days before the transfer and no later than 20 days after the transfer.
- The partnership must prepare Form 8308 or Form 1099-B to report the transaction to the IRS and both the transferor and transferee.
We will continue to update you as more information on these proposed regulations and IRS guidance becomes available. Please contact your Plante Moran international tax services team member if you have any additional questions.
- Proposed regulations under Sec. 1446(f) have instituted a new 10 percent withholding requirements relating to the disposition of partnership interests by non-U.S. partners.
- Proposed regulations under Sec. 864(c) provide guidance on calculating the portion of the gain on the aforementioned disposition that is deemed to be ECI, and is therefore subject to the new withholding regulations.
- Withholding is required to be performed by all purchasers of a partnership interest unless one of six specific exceptions are met to reduce or eliminate entirely the 10 percent withholding requirement.
- Strict reporting requirements have been enacted to enforce the new withholding requirements for partnerships and non-U.S. partners.
- All purchasers and U.S. partnerships should seek to hold on file W-9 forms for all applicable partners, in order to satisfy an exception to the new withholding requirements.