Partnership Withholding on
Effectively Connected Income

A partnership (foreign or domestic) that has income effectively connected with a U.S. trade or business (or income treated as effectively connected) must pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners. A publicly traded partnership must withhold tax on actual distributions of effectively connected income, unless it chooses to withhold under these rules. See Publicly Traded Partnerships, later.

This withholding tax does not apply to income that is not effectively connected with the partnership's U.S. trade or business. That income is subject to NRA withholding tax, as discussed earlier in this publication.

Who Must Withhold

The partnership, or a withholding agent for the partnership, must pay the withholding tax. A partnership that must pay the withholding tax but fails to do so, may be liable for the payment of the tax and any penalties and interest.

Foreign Partner

The partnership must determine whether a partner is a foreign partner. A foreign partner can be a nonresident alien individual, foreign corporation, foreign partnership, or foreign estate or trust.

A partnership may rely on a partner's certification of nonforeign status and assume that a partner is not a foreign partner if the partner provides a certification to the partnership that:

1. States that the partner is not a foreign person,
2. Gives the partner's name, U.S. taxpayer identification number, and address,
3. States that the partner will notify the partnership within 60 days of a change to foreign status, and
4. Is signed under penalties of perjury.

Sample certifications are contained in section 5.04 of Revenue Procedure 89-31, in Cumulative Bulletin 1989-1.

The partnership must keep the certification 5 years after the last tax year in which the partnership relied on it.

Unless the partnership knows that the certification is incorrect, it may rely on it until one of the following happens.

1. The third year after the partnership's tax year in which the certification was made ends.
2. The partner notifies the partnership that it has become a foreign partner.
3. The partnership learns that the partner is a foreign partner.

Widely held and publicly traded partnerships. A partnership with more than 200 partners or a publicly traded partnership may rely on statements received on Form W-9 in lieu of the above certification. It may also rely on a certification from a nominee that a partner owning a partnership interest through the nominee is not a foreign partner. In this situation, the nominee may rely on a partner's certification of nonforeign status as described earlier, or it may rely on Form W-9.

Amount of Withholding Tax

The amount a partnership must withhold is based on its effectively connected taxable income that is allocable to its foreign partners for the partnership's tax year.

The foreign partner's distributive share of the partnership's gross effectively connected income is reduced by the partner's distributive share of partnership deductions for the year. For information on effectively connected income and how to figure a partner's distributive share of income and deductions, see the Instructions for Forms 8804, 8805, and 8813.

A partnership must make installment payments of withholding tax on its foreign partners' share of effectively connected taxable income whether or not distributions are made during the partnership's tax year.

Tax rate. The withholding tax rate on a partner's share of effectively connected income is 35% for a partner taxed as a corporation and 38.6% for all other partners, such as individuals, partnerships, trusts, and estates.

Amount of installment payment. The amount of a partnership's installment payment is the sum of the installment payments for each of its foreign partners. The amount of each foreign partner's installment payment of withholding tax can be figured by using the worksheet in the Instructions for Forms 8804, 8805, and 8813.

Date payments are due. Payments of withholding tax must be made during the partnership's tax year in which the effectively connected taxable income is derived. A partnership must pay the IRS a portion of the annual withholding tax for its foreign partners by the 15th day of the 4th, 6th, 9th, and 12th months of its tax year for U.S. income tax purposes. Any additional amounts due are to be paid with Form 8804, the annual partnership withholding tax return.

A foreign partner's share of withholding tax paid by a partnership is treated as distributed to the partner on the earliest of:

1. The day on which the tax was paid by the partnership,
2. The last day of the partnership's tax year for which the tax was paid, or
3. The last day on which the partner owned an interest in the partnership during that year.

Real property gains. If a domestic partnership disposes of a U.S. real property interest, the gain is treated as effectively connected income and the partnership or withholding agent must withhold following the rules discussed here. A domestic partnership's compliance with these rules satisfies the requirements for withholding on the disposition of U.S. real property interests (discussed later). This also applies to publicly traded partnerships that elect to withhold based on effectively connected income instead of on actual distributions as discussed later.

Reporting and Paying the Tax

Three forms are required for reporting and paying over tax withheld on effectively connected income allocable to foreign partners.

Form 8804, Annual Return for Partnership Withholding Tax (Section 1446). The withholding tax liability of the partnership for its tax year is reported on Form 8804. Form 8804 is also a transmittal form for Forms 8805.

Any additional withholding tax owed for the partnership's tax year is paid (in U.S. currency) with Form 8804. A Form 8805 for each foreign partner must be attached to Form 8804, whether or not any withholding tax was paid.

File Form 8804 by the 15th day of the 4th month after the close of the partnership's tax year. However, a partnership made up of all nonresident alien partners has until the 15th day of the 6th month after the close of the partnership's tax year to file. If you need more time to file Form 8804, you may file Form 2758 to request an extension. Form 2758 does not extend the time to pay the tax.

Form 8805, Foreign Partner's Information Statement of Section 1446 Withholding Tax. Form 8805 is used to show the amount of effectively connected taxable income and any withholding tax payments allocable to a foreign partner for the partnership's tax year. At the end of the partnership's tax year, Form 8805 must be sent to each foreign partner whether or not any withholding tax is paid. It should be delivered to the foreign partner by the due date of the partnership return (including extensions). A copy of Form 8805 for each foreign partner must also be attached to Form 8804 when it is filed.

A copy of Form 8805 must be attached to the foreign partner's U.S. income tax return to take a credit on its Form 1040NR or Form 1120-F.

Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446). This form is used to make payments of withheld tax to the United States Treasury. Payments must be made in U.S. currency by the payment dates (see Date payments are due, earlier).

Penalties. A penalty may be imposed for failure to file Form 8804 when due (including extensions). It is the same as the penalty for Form 1042 discussed earlier under Returns Required.

A penalty may be imposed for failure to file Form 8805 when due (including extensions) or for failure to provide complete and correct information. The amount of the penalty depends on when you file a correct Form 8805. The penalty for each Form 8805 is:

1. $15 if you file a correct form within 30 days, with a maximum penalty of $75,000 per year ($25,000 for a small business), or
2. $50 if you file after 30 days or do not file a correct form, with a maximum penalty of $250,000 per year ($100,000 for a small business).

A small business is a business that has average annual gross receipts of not more than $5 million for the most recent 3 tax years (or for the period of its existence, if shorter) ending before the calendar year in which the Forms 8805 are due.

If you fail to provide a complete and correct Form 8805 to each partner, a penalty of $50 for each failure may be imposed. The maximum penalty is $100,000 per year.

If you intentionally disregard the requirement to report correct information, the penalty for each Form 8805 is the greater of $100 or 10% of the total amount of the items that must be reported, with no maximum penalty.

Identification numbers. A partnership that has not been assigned a U.S. TIN must obtain one. If a number has not been assigned by the due date of the first withholding tax payment, the partnership should enter the date the number was applied for on Form 8813 when making its payment. As soon as the partnership receives its TIN, it must immediately provide that number to the IRS.

To ensure proper crediting of the withholding tax when reporting to the IRS, the partnership must include each partner's U.S. TIN on Form 8805. If there are partners in the partnership without identification numbers, the partnership should inform them of the need to get a number. See U.S. Taxpayer Identification Numbers, earlier.

Publicly Traded Partnerships

A publicly traded partnership that has effectively connected income, gain, or loss must pay withholding tax on any distributions of that income made to its foreign partners. In this situation, a publicly traded partnership must use Forms 1042 and 1042-S ( Income Code 27) to report withholding from distributions. The rate of withholding is 38.6%.

A publicly traded partnership is any partnership an interest in which is regularly traded on an established securities market or are readily tradeable on a secondary market. These rules do not apply to a publicly traded partnership treated as a corporation under section 7704 of the Internal Revenue Code.

Foreign partner. The partnership determines whether a partner is a foreign partner using the rules discussed earlier under Foreign Partner.

Election to withhold on effectively connected taxable income. A publicly traded partnership can elect to withhold on its effectively connected taxable income allocable to foreign partners instead of on its actual distributions. The partnership makes this election by filing Forms 8804, 8805, and 8813 and by complying with the payment and reporting requirements for those forms, as discussed earlier. Once the election has been made, it can be revoked only with the consent of the IRS.

Distributions subject to NRA withholding. If the election to withhold on effectively connected taxable income is not made, the partnership must withhold tax on any actual distributions of money or property to foreign partners. In the case of a partnership that receives a partnership distribution from another partnership (a tiered partnership), the distribution also includes the tax withheld from that distribution.

If the distribution is in property other than money, the partnership cannot release the property until it has enough funds to pay over the withholding tax.

A publicly traded partnership that complies with these withholding requirements satisfies the requirements discussed later under U.S. Real Property Interest. Distributions subject to withholding include:

1. The fair market value of U.S. real property interests distributed to a partner and potentially subject to withholding under section 1445(e)(4) of the Internal Revenue Code,
2. Amounts subject to NRA withholding under section 1445(e)(1) of the Internal Revenue Code on distributions pursuant to an election under section 1.1445-5(c)(3) of the regulations, and
3. Amounts not subject to NRA withholding under section 1445 of the Internal Revenue Code because the distributee is a partnership or is a foreign corporation that has made an election to be treated as a domestic corporation.

Excluded amounts. Partnership distributions are first considered to be paid out of the following types of income in the order listed. To the extent the partnership has this type of income, it is excluded from the distributions subject to withholding discussed in this section.

1. Amounts of noneffectively connected income distributed by the partnership and subject to NRA withholding discussed earlier.
2. Amounts attributable to recurring dispositions of crops and timber that are subject to NRA withholding under section 1.1445-5(c)(3)(iv) of the regulations.
3. Amounts attributable to the disposition of a U.S. real property interest subject to the withholding rules discussed next under U.S. Real Property Interest.

For more information about the withholding requirements for publicly traded partnerships, see Revenue Procedure 89-31 in Cumulative Bulletin 1989-1.

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