IRS Notice 2018-14: Partnership Interest Sale Withholding
Navigate the transferee's tax withholding duties under Notice 2018-14 for partnership interest sales by foreign persons, including paths to reduce or eliminate the tax.
The Tax Cuts and Jobs Act (TCJA) enacted Internal Revenue Code Section 1446(f), establishing a withholding tax requirement on the sale or exchange of a partnership interest by a foreign person. This rule serves as an enforcement mechanism for Section 864(c)(8), which treats gain from such a sale as income effectively connected with a U.S. trade or business. The regulations place the primary withholding obligation on the buyer of a partnership interest from a foreign seller, ensuring the collection of U.S. tax on gains from these dispositions.
The Withholding Obligation on the Transferee
A withholding obligation is placed upon the buyer, or “transferee,” when purchasing a partnership interest from a foreign seller, or “transferor.” Under Section 1446(f), the transferee must withhold a tax equal to 10% of the amount realized on the disposition. This requirement applies if any of the seller’s gain is considered effectively connected with a U.S. trade or business.
The “amount realized” is not limited to cash paid. It also includes the fair market value of any property transferred and the transferor’s share of partnership liabilities that the transferee assumes. The inclusion of assumed liabilities significantly expands the base on which the 10% withholding is calculated, a detail that can be overlooked.
For instance, if a transferee pays $100,000 in cash for a foreign partner’s interest and assumes the partner’s $400,000 share of liabilities, the amount realized is $500,000. The required withholding would be 10% of $500,000, which is $50,000. This amount is half of the actual cash paid in the transaction.
The transferee must conduct due diligence to determine the transferor’s share of partnership liabilities. If the transferee fails to withhold the correct amount, the partnership can be held responsible. The partnership must then deduct the shortfall, plus interest, from future distributions to that transferee.
Exceptions to the Withholding Requirement
The regulations provide several exceptions that can eliminate the transferee’s obligation. These exceptions usually require a certification from the transferor or the partnership.
Certification of Non-Foreign Status
The transferee is relieved of the withholding duty if they receive a certification from the seller stating they are not a foreign person. This affidavit must be made under penalties of perjury. It must also include the transferor’s name, U.S. taxpayer identification number (TIN), and home address.
No Realized Gain
Withholding is not required if the transaction results in no realized gain for the seller. The transferee must obtain a certification from the transferor stating this fact. This can occur if the partner’s basis in the interest equals or exceeds the amount realized from the sale.
Partnership Certification on Assets
A transferee is not required to withhold if they obtain a statement from the partnership. The statement must certify that if the partnership sold all its assets at fair market value, the gain effectively connected with a U.S. trade or business would be less than 10% of the total gain.
Tax Treaty Exception
An exception is available if the gain on the transfer is not subject to U.S. tax under an income tax treaty. The transferee must receive a certification from the transferor claiming this exemption. The certification must state the transferor is not subject to tax on the gain due to a treaty.
Certification for Reduced Withholding
If the seller’s tax liability on the gain is less than 10% of the amount realized, the withholding can be reduced. The transferee must receive a certification from the transferor that provides the maximum tax liability owed on the gain. The transferee can then withhold this certified, smaller amount.
Publicly Traded Partnerships
The rules for interests in publicly traded partnerships (PTPs) are different. For these transactions, the withholding obligation is on the broker processing the sale, not the buyer. Brokers are required to withhold 10% of the amount realized on the sale of a PTP interest by a foreign partner.
The main exception to this rule is when the PTP issues a “qualified notice” stating it meets the “10 percent exception.” This means if the PTP sold all its assets at fair market value, the gain effectively connected with a U.S. trade or business would be less than 10% of the total gain. If a PTP posts such a notice, a broker is not required to withhold.
How to Report and Pay the Withheld Tax
The withholding agent, either the transferee or broker, must report and pay the tax to the IRS. The forms used for this are Form 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests.
The withholding agent must file Form 8288 and pay the tax by the 20th day after the date of the transfer. The agent also prepares Form 8288-A for the foreign transferor. After the IRS processes the forms, it will stamp Copy B of Form 8288-A and mail it to the transferor. This stamped form is the official proof of withholding, which the foreign seller must attach to their U.S. income tax return to claim a credit.
If a transferee fails to withhold, the partnership may be required to withhold the tax from distributions to that transferee. In this situation, the partnership uses Form 8288-C to report and pay the amount.