PARTNERS OF U.S. PARTNERSHIPS
TAXATION OF FOREIGN PARTNERS
An individual foreign partner of US partnership must file Form 1040NR if the partnership is engaged in a trade or business in the United States, regardless of whether the partnership has any income from the conduct of a trade or business in the United States or the income is exempt from tax under a treaty or a provision of the code.
A taxpayer who files Form 1040NR may also be required to file Form 8833, Treaty-Based Return Position Disclosure Under Code Sec. 6114 or 7701(b); Form 8840, Closer Connection Statement.
A foreign partner's income that is subject to U.S. income tax must be divided into two categories.
1. Income that is effectively connected with a trade or business in the United States, and
2. Income that is not effectively connected with a trade or business in the United States.
The difference between these two categories is that effectively connected income, after allowable deductions, is taxed at graduated rates. These are the same rates that apply to U.S. citizens and residents. Income that is not effectively connected is taxed at a flat 30% (or lower treaty) rate. If you were formerly a U.S. citizen or resident alien, these rules may not apply.
Generally, a foreign partner must also file a state tax return. Please note that state tax rules are complicated and every state has its own set of rules. When state tax rules are not followed, there are penalties and interest imposed.
It is important to note that if during a partnership's tax year the partnership has taxable income effectively connected with the conduct of a trade or business within the United States that is allocable to a foreign partner, the IRS requires the partnership to report and pay a withholding tax under IRC Section 1446. The partnership must pay the IRC section 1446 withholding tax regardless of the amount of foreign partners' ultimate U.S. tax liability and regardless of whether the partnership makes any distributions during its tax year.
In addition to the requirement to withhold under IRC section 1446, U.S. source income that is not effectively connected with the partnership's U.S. trade or business may be subject to withholding as required under IRC sections 1441, 1442, and 1443.
(Refer to Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons and Form(s) 1042-S, Foreign Person's U.S. Source Income Subject to Withholding)
Generally, a state authority also requires withholding on payments made to nonresidents for income received from state sources. Please note that state tax rules are complicated and every state has its own set of rules. When state tax rules are not followed, there are penalties and interest imposed.
Is It Time to Update Foreign Partners' U.S. TINs?
In order for a foreign partner to claim a refund a valid Taxpayer Identification Number (TIN) is required. A foreign partner must file an income tax return (Form 1040NR, Form 1120F, etc.) with a valid TIN.
Are You Aware of This?
This is especially important with respect to partnership withholding. A foreign or domestic partnership that has effectively connected taxable income allocable to a foreign partner must pay a withholding tax under IRC section 1446 equal to the applicable percentage of the effectively connected taxable income that is allocable to its foreign partners. A partnership must pay the withholding tax for a foreign partner even if the partnership does not have a U.S. TIN for that partner.
Foreign partners must attach Form 8805 to their U.S. income tax returns to claim a credit for their share of the IRC section 1446 tax withheld by the partnership. To insure proper crediting of the withholding tax when reporting to the IRS, a partnership must provide a U.S. taxpayer identification number (TIN) for each foreign partner. The partnership should notify any of its foreign partners without a valid TIN of the necessity of obtaining a U.S. taxpayer identification number. An individual's taxpayer identification number is the individual's social security number (SSN) or individual taxpayer identification number (ITIN). An ITIN will always begin with a 9, and the middle two digits will be in the range of 70 to 80. It is also possible that a partner's TIN could be its U.S. employer identification number (EIN).