In 2019, a partnership likely will have to report how many foreign partners were subject to 10% withholding because an interest in the partnership was transferred.
The IRS has issued a draft Form 1065, U.S. Partnership Information Return, for 2019 with a line requiring this information.
A disposition of a partnership interest includes:
- a transfer of an interest in the partnership; or
- the receipt of an interest in the partnership in a distribution.
Reporting Tax Withheld: Form 1065 and Form 8288
IRC section 1446(f)(1) imposes a 10% tax on a foreign person when they sell or receive a distribution of a partnership interest. However, the tax applies only when gain on the transfer is effectively connected income (ECI) from a U.S. trade or business under section 864(c)(8).
Typically, the tax is withheld by:
- the buyer; or
- the partnership making the distribution.
A buyer or other transferee files Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, to report withholding.
For example, a foreign buyer has to withhold 10% of effectively connected gain realized by the seller of the partnership interest. The buyer files Form 8288 for the tax year of the sale, remitting the tax withheld.
Additional Information From Partnerships Simplifies IRS Exams
However, Schedule B of draft Form 1065 for 2019 includes Question 27, requiring partnerships to note the number of foreign partners with effectively connected gain subject to withholding tax.
A partnership would include foreign partners even if the partnership was not responsible for withholding tax when distributing an interest.
Foreign partners include nonresident alien individuals and foreign corporations.
According to the IRS, additional information on filed Forms 1065 will assist it when it examines returns. Knowing the number of partners that transferred or received a partnership interest and realized an effectively connected gain or loss would help the IRS with:
- judging general compliance risk;
- spotting possible noncompliance; and
- making sure fewer compliant taxpayers are examined.
Draft Form 1065 Changes Reflect Statutory Change
withholding requirement for sales or exchanges by foreign partners is not new
by IRS standards. However, section
codifies the requirement, was enacted in the Tax Cuts
and Jobs Act (TCJA) in
response to a 2017 tax court ruling. In Grecian
Magnesite Mining, the tax
court held that in general, a foreign person’s gain or loss on the sale of an
interest in a partnership engaged in a U.S. trade or business is foreign source.
Treasury has issued proposed regulations for withholding tax on the transfer or distribution of a partnership interest to a foreign person. Taxpayers can rely on these rules until Treasury issues final regulations.
Withholding for Publicly Traded Partnerships
The proposed regulations provide rules for withholding and reporting on the transfer of an interest in a publicly traded partnership (a PTP interest).
However, the IRS has temporarily suspended the withholding rules for dispositions of PTP interests. The withholding obligation is generally limited to brokers that receive proceeds from the sale and act on behalf of the transferor.
Since the regs are suspended, it’s unclear whether PTPs would be required to complete Question 27 if it’s included on Form 1065 for 2019. However, all other partnerships with income effectively connected to a U.S. trade or business would have to meet this reporting requirement.
Will the Draft From 1065 be the Final Form 1065?
The IRS did accept comments on the 2019 draft Form 1065, for 30 days, as required, so the IRS might make more changes. But, in its notice that accompanied the release of the 2019 draft Form 1065, the IRS stated that the draft is “intended to give tax practitioners a preview of the changes and software providers the information they need to update systems before the final version of the updated forms and schedules are released in December.”
On October 29, 2019, the IRS issued draft instructions for Form 1065. This draft does not include instructions for Question 27 on Schedule B.
Partnerships with foreign partners should prepare to gather this information for 2019 reporting.
By Lisa Lopata, J.D.