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Sunday, September 04, 2005

Foreign Partner Withholding Tax Regulations

§1446 of the Internal Revenue Code imposes a withholding tax on a partnership's effectively connected taxable income allocable to a foreign partner. The tax is imposed at the highest applicable income tax rate of the partner. Recently issued regulations provide some helpful provisions in applying the withholding tax. These include -

-temporary regulations that allow a foreign partner to certify to the partnership certain partner-level deductions and losses that are connected with gross income that is effectively connected with the partner's U.S. trade or business and that the partner reasonably expects to be available to reduce the Code Sec. 1446 tax on its share of the partnership's ECTI.

-the ability of the partnership to consider the character of income or gain (e.g., long-term capital gain, unrecaptured Code Sec. 1250 gain, etc.) allocated to a foreign partner when computing the Code Sec. 1446 tax liability. Thus, for example, long-term capital gain that is allocable to a noncorporate foreign partner will be subject to the highest long-term capital gains rate, which currently is 15%.

-treating the deemed distribution (under Code Sec. 1446(d) ) of the partnership withholding tax as an advance or draw against the partner's distributive share of the partnership's ECTI. This allows the recipient partner to take the distribution into effect at the end of the tax year for purposes of determining whether the distribution exceeds its basis in its partnership interest - that is, after its basis is increased for its allocable share of net income of the partnership for that tax year. This applies, however, only to tax payments applicable to ECTI of that particular tax year.

Rubinger, 103 Journal of Taxation 166 (September 2005)

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