§1446 Withholding of Tax on Foreign Partners’ Share of Effectively Connected Income

Summary

Partnerships must withhold tax when they have income connected to a U.S. business and some of that income is allocated to partners who are not U.S. persons. The amount to withhold is the “applicable percentage” of that effectively connected taxable income that is allocated to foreign partners. The applicable percentage is the highest tax rate in section 1 for non-corporate foreign partners and the highest tax rate in section 11(b) for foreign corporate partners. Effectively connected taxable income means the partnership’s taxable income tied to a U.S. trade or business, figured with three adjustments: one rule in section 703(a)(1) does not apply; depletion for oil and gas is allowed but figured without regard to sections 613 and 613A; and any items allocated to U.S. partners are ignored. A foreign partner may claim a credit under section 33 for their share of the withholding in the partner’s tax year that includes the partnership year end. The partner’s share is treated as distributed either when the partnership pays the tax or on the last day of the partnership year, whichever comes first, unless rules say otherwise. If a buyer of a partnership interest would have gain treated as effectively connected under section 864(c)(8), the buyer must withhold 10% of the amount realized. The seller can avoid withholding by giving a sworn statement with a U.S. taxpayer ID number saying they are not a foreign person, unless the buyer knows it’s false or rules require sending a copy to the IRS. The IRS may allow a smaller withholding, make rules, or provide exceptions. If the buyer fails to withhold, the partnership must withhold that unpaid amount from payments to the buyer, plus interest.