Foreign or domestic partnerships that have effectively connected income (ECI) with a U.S. trade or business are generally required to withhold tax on taxable ECI that is allocable to its foreign partners.
The Tax Cuts and Jobs Act of 2017 (TCJA) codified the IRS’s position detailed in Rev. Rul. 91-32 by adding Section 864(c)(8) which characterizes a non-U.S. partner’s gain or loss from the sale or exchange of a partnership interest as ECI to the extent the non-U.S. partner would have had effectively connected gain or loss “if the partnership had sold all of its assets at their fair market value as of the date of the sale or exchange of such interest.”
TCJA also added Section 1446(f) as a correlative withholding tax provision to Section 864(c)(8). Subject to certain exceptions, Section 1446(f) imposes a 10% withholding tax on the transferee of a partnership interest based on the amount realized on the disposition of the partnership interest if any portion of the gain on the disposition is treated as effectively connected with the conduct of a U.S. trade or business.
On November 30, 2020, the IRS and Treasury Department issued final regulations (T.D. 9926) which provide further guidance with respect to:
- Reporting requirements for foreign transferors and partnerships with foreign transferors
- Scope of the withholding obligation under Section 1446(f)
- Withholding on the transfer of a non-publicly traded partnership interest
- Partnership’s requirement to withhold under Section 1446(f)(4) on distributions to transferee
- Withholding on the transfer of a publicly traded partnership interest by a foreign person
- Amendments to existing Section 1446 regulations relating to distributions by publicly traded partnerships
The tax withholding provisions in the final regulations are generally effective with respect to transfers that occur on or after the date that is 60 days after the publication of the final regulations in the Federal Register. The final regulations retain the general applicability date by which the general rules would impact transfers occurring on or after January 29, 2021. However, in consideration of public comments received, the IRS announced in Notice 2021-51 that it intended to amend the regulations under Sections 1446(a) and 1446(f) to defer the applicability date to January 1, 2023, for the following withholding tax provisions:
- Withholding under Section 1446(f) on transfers of interests in publicly traded partnerships (PTP interests)
- Withholding under Section 1446(a) on distributions made with respect to PTP interests
- Withholding under Section 1446(f)(4) by partnerships on distributions to transferees
On December 21, 2022, the IRS released Notice 2023-8 to provide relief only to transfers of PTP interests. For partnerships that are not PTPs, the extended applicability date on January 1, 2023 for withholding tax under Section 1446(f)(4) on distributions to transferees may be the most relevant for the 2023 tax year.
To explain further, Section 1446(f)(4) imposes certain secondary withholding obligations upon a partnership. The final regulations provide that a partnership will be required to withhold on distributions to the transferee if the transferee fails to withhold the required amount (including interest) under Section 1446(f)(1). The final regulations further provide that to be relieved from its withholding obligation under Section 1446(f)(4), the partnership must receive, within 10 days after the date of the transfer, a certification from the transferee that would either establish that the transferee has satisfied its withholding obligations or that one of the regulatory exceptions would apply. Unless the IRS issues additional relief, the secondary withholding obligation would be considered effective on January 1, 2023.
All partnerships that are directly or indirectly engaged in a U.S. trade or business should work closely with their tax advisors to evaluate the withholding tax requirements, if any, and ensure timely payment and reporting for withholding taxes under Section 1446(f)(4) for any transfers of partnership interests by non-U.S. investors occurring on or after January 1, 2023.
For more information, reach out to Gary Zhang at gzhang@citrincooperman.
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