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Withholding Tax on a Foreign Partnership

With a foreign partnership, you may need to pay a withholding tax on that partner.  A partnership that has income effectively connected with a U.S. trade or business is required to pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners.  A foreign partner is anyone who is not considered a U.S. person.  This includes nonresident aliens, foreign corporations, foreign partnerships, and foreign trusts or estates.

The partnership must pay the withholding tax regardless of the foreign partner’s ultimate U.S. tax liability for the year and even if the partnership did not make any distributions during the year.  The amount of withholding tax is the highest tax rate at that time (35% in 2009).  The effectively connected taxable income is income that is effectively connected to a U.S. trade or business. Generally speaking, non effectively connected U.S. source income (fixed, determinable, annual and periodic) should be withheld on a gross basis at 30% unless the treaty provides for a reduction in this amount.

The partnership agreement should be reviewed to determine the allocable amount to each partner.  Each foreign partner will have his equity account adjusted to reflect the applicable tax payment remitted on his behalf. These payments are then reported on the foreign partner’s U.S. income tax return and will offset the U.S. tax liability ultimately assessed on him personally.

The withholding tax must be paid on a quarterly basis, before the fifteenth day of the fourth, sixth, ninth, and twelfth months of the partnership’s tax year.  Therefore, the partnership should review the allocable foreign partner’s share of taxable income throughout the year and pay the withholding tax accordingly to avoid any penalties at year end.

Please note:

This information is not intended to provide a recommendation on how to structure an interest in U.S. real property.  The final decision must be based on what works best given the specific facts. Any decision must also take into consideration what is important to the investor(s), taking into account their different objectives, risk tolerances and sensitivities with respect to the various issues involving U.S. income tax, estate tax, confidentiality and domicile taxation. Additional treaty benefits may apply depending upon the domicile of the client.  No purchase or investment structure should be implemented based solely on information provided in this article and, in addition, home country tax advice should also be obtained before selection of ownership structure.

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