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IRC 1446 Withholding Requirements for Foreign Partner’s

Effectively Connected Income: Forms 8804 and 8288

WEDNESDAY, FEBRUARY 20, 2019, 1:00-2:50 pm Eastern

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WEDNESDAY, FEBRUARY 20, 2019

IRC 1446 Withholding Requirements for Foreign Partner's Effectively Connected Income: Forms 8804 and 8288

Gregory P. Broome, Partner

Wilson Sonsini Goodrich & Rosati, San Francisco

[email protected]

Alison N. Dougherty, J.D., LL.M., Tax Director

Wagner Duys & Wood, Bethesda, Md.

[email protected]

C. Edward Kennedy, Jr., CPA, JD, Managing Director

C. Edward Kennedy Jr., Atlanta

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

The information contained herein is of a general nature and based on authorities that are

subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.

IRC 1446 Withholding Requirements for Foreign Partner's Effectively Connected Income: Forms 1042-S, 8804, and 8288

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Identifying Foreign Partners and Offshore Partnership Structures

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Outline

• Identifying foreign partners and offshore partnership structures

• Determining FDAP income and discussing the reporting requirements on Forms 1042,1042-S, and Schedule K-1 as they apply to partnerships with foreign partners

• Calculating effectively-connected taxable income (ECTI) • Section 1446 tax liability• Reporting ECTI on Form 8804, 8805, 8813, and Schedule K-1

• Rules and requirements specific to U.S. real estate holdings • Determining what is a U.S. real property interest for purposes of Section 897• Section 1445 withholding requirements on dispositions of U.S. real property

interests• Section 864(c)(8)(C) and 897 coordination provisions subjecting certain gains on

sale of foreign partnership interests to the Foreign Investment in Real Property Tax Act (FIRPTA) withholding provisions rather treating such gains as ECTI subject to withholding under Section 1446

• Form 8288• Affidavits and exemptions

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Who is a Foreign Partner?

• A Foreign Partner is any partner who is not a U.S. Person.

• As such, a foreign person includes a nonresident alien individual, foreign corporation, foreign partnership, foreign trust or estate, or a foreign organization described in section 501(c).

• A partnership can determine a partner's foreign or nonforeign status by relying on a W-8 form (for example, Form W-8BEN), Form W-9, an acceptable substitute form, or by other means.

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Where do you find Foreign Partners?• You can find Foreign Partners anywhere there is a

partnership – domestic or foreign

• It’s easy enough when you have a domestic partnership, right?

• But, as with many things in international tax, just because something says its something doesn’t mean it’s that something

• Remember the old adage: “Who are my friends? Those who are not my enemies.”

• So, who are our Foreign Partnership friends?

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What is a Partnership?

• Let’s start with the basics:

• A joint undertaking merely to share expenses is not a partnership. Mere co-ownership of property that is maintained and leased or rented is not a partnership. However, if the co-owners provide services to the tenants, a partnership exist

• A partnership is the relationship between two or more persons who join to carry on a trade or business, with each person contributing money, property, labor, or skill and each expecting to share in the profits and losses of the business whether or not a formal partnership agreement is made.

• The term “partnership” includes a limited partnership, syndicate, group, pool, joint venture, or other unincorporated organization, through or by which any business, financial operation, or venture is carried on, that is not, within the meaning of the regulations under section 7701, a corporation, trust, estate, or sole proprietorship.

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What is a Partnership?

• Treasury Regulation (Treas. Reg.) §301.7701-3 addresses the treatment of domestic and foreign “business entities”

• A “business entity” is any entity recognized for federal income tax purposes which is not classified as a trust under Treas. Reg. §301.7701-4 or subject to special treatment under the Code

• Entities which are not “per se” corporations are eligible to either use its default classification or elect its treatment on Form 8832

• These entities are considered “eligible entities”

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What is a Domestic v. Foreign Partnership?

• A domestic partnership is a partnership that is created or organized in the United States or under the law of the United States or of any state or the District of Columbia.

• A foreign partnership is a partnership that is not created or organized in the United States or under the law of the United States or of any state or the District of Columbia.

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What Are the Default Classifications?

• Unless an election is made on Form 8832, a domestic eligible entity is treated as follows:

• A partnership if is has two or more members

• Disregarded as an entity separate from its owner if it has a single owner

• Unless an election is made on Form 8832, a foreign eligible entity is treated as follows:

• A partnership if is has two or more members and at least one member does not have limited liability

• An association taxable as a corporation if all members have limited liability

• Disregarded as an entity separate from its owner if it has a single owner that does not have limited liability

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Default Classification – U.S. Entity

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Entity Created Under U.S. Law

Trust Business Entity

Per Se Corporation

Eligible Entity

>1 Member = Partnership 1 Member

= DRE

Default Classification– Foreign Entity

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Entity Created Under Foreign

Law

Trust Business Entity

Per Se Corporation

Eligible Entity

>1 Member

1 Member = DRE

No member unlimited liability

= Association

Any member unlimited liability =

Partnership

What Entity Elections Are Available?

• An entity with only one owner can elect to be taxed as a DRE or an association taxable as a corporation

• An entity with more than one owner can elect to be classified as a partnership or an association taxable as a corporation

So What Does This Mean?

• Just because a foreign business entity is a partnership under local law doesn’t make it a partnership for U.S. purposes

• If the business entity has at least one owner with unlimited liability, it is considered a partnership under the default classification

• If no owner has unlimited liability, then an election to be taxed as a partnership needs to be made on Form 8832

• Otherwise, this entity is a corporation for U.S. tax purposes and Form 5471, not Form 8865, should be filed

FDAP Income and Reporting Requirements as They Relate to Foreign Partners

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Purpose of this Section

• Not a detailed discussion of Form 1042 and 1042-S withholding and reporting requirement

• Not a detailed discussion Form W-8BEN-E either

• Instead, it is intended to separate out the types of payments required to be reported on Form 1042 as opposed to those required to be reported on Forms 8804 et. seq. as they relate to foreign partners

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One Comment With Respect to Form W-8BEN-E• You absolutely must obtain a Form W-8BEN-E

(Form W-8 if an individual partner) to properly complete the Form 1042-S

• Otherwise you cannot provide their Chapter 3 and 4 status codes

• Failure to file correct forms can result in significant penalties (discussed later)

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FDAP Income Withholding

• These forms are used to withhold and report fixed, determinable, annual, or periodical (FDAP) income of a nonresident alien or foreign corporation received from U.S. sources

• FDAP income includes interest, dividends, rents, salaries, wages, premiums, annuities, compensation, remunerations, emoluments, and any other item of annual or periodical gain, profit, or income

• This income is generally taxed at a flat 30-percent rate (or lower rate permitted under a tax treaty) if the income is not effectively connected with the conduct of a U.S. trade or business

• This tax must be withheld from the payor of the FDAP income

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Partnership Withholding Implications• FDAP income is not included in the Form 8804

withholding under Section 1446 and reported on Forms 8804 et. seq.

• Instead it is reported on Forms 1042 and 1042-S

• Special rules also apply to FDAP subject to withholding attributable to a preceding calendar year which is being withheld upon in a subsequent year pursuant to Treas. Reg. §1.1441-5

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Forms Involved

• Form 1042 is the annual withholding tax return filed by the withholding agent

• Form 1042-S is the form provided to various parties document the withholding

• Copy A for IRS

• Copy B for recipient

• Copy C for recipient to attach to Federal income tax return

• Copy D for recipient to attach to any state tax return

• Copy E for withholding agent

• Form 1042-T is the form used annually to summarize and transmit all Forms 1042-S provided by a payor

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Penalties

• Late filing of correct Form 1042-S:• $50 per Form 1042-S if correctly filed within 30 days after the

required filing date; the maximum penalty is $545,500 per year ($191,000 for a small business)

• $100 per Form 1042-S if correctly filed more than 30 days after the due date but by August 1; the maximum penalty is $1,637,500 per year ($545,500 for a small business)

• $270 per Form 1042-S if filed after August 1 or the taxpayer does not file correct Forms 1042-S; the maximum penalty is $3,275,500 per year ($1,091,500 for a small business)

• For taxpayers who intentionally disregard the requirement to report correct information, the penalty per Form 1042-S is increased to the greater of $540 or 10% of the total amount of items required to be reported, with no maximum penalty.

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Penalties

• Failure to furnish correct Form 1042-S to recipient without reasonable cause:

• Up to $270 may be imposed for each failure to furnish Form 1042-S to the recipient when due

• The penalty also may be imposed for failure to include all required information or for furnishing incorrect information on Form 1042-S

• The maximum penalty is $3,275,500 for all failures to furnish correct recipient statements during a calendar year

• Filing correct information before August 1 may result in reduced penalties

• Intentional disregard of the requirement to report correct correct information increases the $270 penalty to the greater of $540 or 10% of the total amount of items required to be reported, with no maximum penalty

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Penalties

Failure to file electronically

• Taxpayers required to file electronically but who fail to do so, and do not have an approved waiver on record, may also be subject to penalties unless they establish reasonable cause for such failure

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C. Edward “Ed” Kennedy JrManaging DirectorC Edward Kennedy Jr PC

Ed has over 3 years of experience dealing with a variety of international tax matters. He specializes in tax consulting services to a wide variety of clients ranging from closely held companies to multi-national businesses. His expertise includes domestic and foreign income and social security tax planning, tax compliance for individuals and corporations, tax treatment of incentive compensation plans, international assignment program administration and policy design. Ed has also served as the practice lead for a Big 4 CPA Firm’s international social security practice.

GrossDukeNelson & Co.

C Edward Kennedy JrManaging DirectorC Edward Kennedy Jr PC1510 Misty Oaks DriveAtlanta, GA 30350Tel 404-202 [email protected]

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Three-Step Computational Approach

The proposed regulations set forth a three-step process for calculating the amount of gain or loss otherwise recognized by a foreign partner on the transfer of a partnership interest that is treated as an effectively connected gain or loss.

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Step 1: Determine the partnership’s deemed sale gain or loss.

• Equals the amount of gain or loss the partnership would recognize upon a sale of its assets to an unrelated third party for cash equal to fair market value.

• Must determine the amount of deemed sale gain or loss separately for each asset. Purchase Price Allocation becomes important.

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Step 2: Determine the amount of the partnership’s deemed sale gain or loss that would be treated as an effectively connected gain (“deemed sale EC gain”) or loss (“deemed sale EC loss”).

• Deemed sale gain or loss determined in Step 1 is presumed to beattributable to an office or other fixed place of business maintained by thepartnership in the United States.

• Exception: deemed sale gain or loss is not to be treated as US-sourced if (i)no income from the asset was taxable as ECI of the partnership during theprior 10-year period and (ii) the asset has not been used/held for use, inthe conduct of a business within the U.S. by the partnership (or apredecessor of the partnership) during the prior 10-year period.

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Step 2 Continued: Determine the amount of the partnership’s deemed sale gain or loss that would be treated as an effectively connected gain (“deemed sale EC gain”) or loss (“deemed sale EC loss”).

• The presumption of being US-source may result in more gain that an actual sale, e.g. inventory treated differently (general sourcing rule for inventory: gain not treated as US-source if the inventory is sold for use, disposition, or consumption outside the United States and an office or other fixed place of business maintained by the partnership in a foreign country materially participated in the sale.

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Step 3: Determine foreign partner’s distributive share partnership’s deemed sale effectively connected gain (or loss) from each asset.

• A foreign partners distributive share of deemed sale gain or loss generally equals the amount of such gain or loss that would be allocated to the partner under the partnership agreement.

– Partial transfer, proportionate recognition.

• Gain or loss from hot Assets is computed separately.

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Step 3 Continued: Determine the foreign partner’s distributive share of the partnership’s deemed sale EC gain or deemed sale EC loss from each asset.

• The amount of ordinary income or loss under Section 751 will be treated as an effectively connected gain or loss under Section 864(c)(8) to the extent of the foreign partners aggregate deemed sale gain or loss attributable to hot assets.

• Section 741 applies otherwise.

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ECI Examples

Examples from 1.864(c)(4) Regulations.

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Examples

Assumptions:

• Domestic partnership

• Foreign partner (FP) has $100 outside basis

• 50% allocation percentage

• Certain assets not attributable to fixed place of business in U.S. while other assets are and would generate ECI.

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Examples

• Example 1 Facts

• FP sells entire interest for $105

• Partnership has U.S. capital asset—basis $100;FMV of $104.

• Partnership also has Non-U..S. capital asset with basis of $100;

FMV of $106.

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Examples

Example 1 Analysis

• FP total outside gain is $5 —all would be capital gain under section 741 since all inside gain is capital. All $5 of gain is ECI gain to the extent it does not exceed FP’s share of ECI gain from deemed asset sale.

• Deemed gain from asset sale would be $4 with respect to the U.S. asset and $6 with respect to the non-U.S. asset.

• FP’s share of ECI gain from deemed asset sale is $2.

• None of the foreign asset gain is ECI.

• FP reports the lesser of o/s gain ($5) and the EC gain ($2).

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Examples

Example 2 Facts

• FP sells interest for $110.

• Domestic partnership owns capital 2 assets; U.S. asset with an inside basis of $100; FMV of $150 and non-U.S. asset with a basis of $100 and FMV of $70.

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Examples

Example 2 Analysis

• FP’s total outside gain is $10—all would be capital gain under section 741 since all inside gain is capital. That $10 of gain is ECI gain to the extent it does not exceed FP’s share of ECI gain from deemed asset sale.

• Deemed asset sale would have produced a $50 capital gain on the domestic side and a $30 loss of the non-US side.

• FP’s share of ECI from deemed asset sale is $25 (50% of $50).

• FP reports $10 of ECI gain because it does not exceed its ECI gain of $25 from deemed asset sale.

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Examples

Example 3 Facts

• FP sells entire interest for $95.

• Domestic partnership owns 4 assets: (1) U.S. capital asset with basis of $20; FMV of $50;(2) U.S. 751 asset basis of $30;FMV of $50;(3) non-U.S. capital assets with basis of $100 and FMV of $80 and non-U.S. 751 asset with basis of $50 and FMV of $10.

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Examples

Example 3 analysis.• FP has an outside loss of $5 on sale of interest.• Deemed asset sale would have produced the following: (1) U.S.

capital gain of $30; (2)US 751 gain of $20;(3) non-U.S. ordinary loss of $20; and (4) non-U.S. 751 loss of $40.

• Capital gain calculation: FP o/s share of capital gain is $5 (50% of ($30 (U.S.) -$20(Non-U.S.). Since that is less than its $15 share of ECI gain, FP reports $5 of ECI gain.

• 751 Calculation: FP’s o/s share of 751 items is a is -$10 (50% of Non-U.S. loss of $40 reduced by U.S. 751 gain of $20). And that loss is treated as ECI loss to the extent it does not exceed FP’s share of loss from deemed sale.

• FP’s share of loss from deemed sale is zero (it was actually a gain), so none of the $5 loss is ECI loss.

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Tiered Partnerships

• Look-through approach to tiered partnership structures.

• Determine the deemed sale gain or loss and the deemed sale effectively connected gain or in each lower-tier partnership, beginning with the lowest partnership in the chain of ownership.

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Non-Recognition Rules

• Gain or loss on the transfer of a partnership interest that is subject to tax as effectively connected gain or loss is limited to the gain or loss otherwise recognized under the Code.

• Additional guidance is needed for partial non-recognition transactions.

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Withholding Under 1446(f)

• On April 2, 2018, the U.S. Treasury Department and the Internal Revenue Service (IRS) issued Notice 2018-29, "Guidance Regarding the Implementation of New Section 1446(f) for Partnership Interests That Are Not Publicly Traded" (the Notice), addressing Sections 1446(f) and 864(c)(8) of the Internal Revenue Code of 1986 (the Code).

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Certification That Transferor Is a U.S.Person or That No Gain Will Be Realized

• The Notice states that the Treasury Department and the IRS intend to issue regulations, as contemplated by Section 1446(f)(2), providing for the issuance of a certificate to inform the transferee of a partnership interest that withholding is not required where the transferor is not a foreign person.

• Similar to FIRPTA in that there are certifications a buyer can rely on to determine if it must withhold.

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Certification of Less Than 25 Percent ECI

• Exception to Section 1446(f) withholding interests if: (i) the transferor provides a certification to the transferee that (A) the transferor was a partner in the partnership for the entirety of the prior three taxable years and (B) less than 25 percent of the transferor's distributive share of partnership income for those three taxable years was ECI; or (ii) the partnership provides a certification that less than 25 percent of the partnership's gain from the hypothetical sale of its assets for fair market value would constitute ECI.

• The Notice states that the Treasury Department and the IRS intend to provide future guidance that will lower these 25 percent thresholds.

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Calculation of Amount Realized

• If Section 1446(f) withholding applies to a transfer, the transferee must withhold 10 percent of the "amount realized" by the transferor in the transaction, which includes both the proceeds paid to the transferor and any reduction in the transferor's share of partnership liabilities or liabilities to which the transferred partnership interest is subject. The Notice provides that, for purposes of determining the amount of any liability of the partnership included in the amount realized, the transferee may rely on a certificate as to the amount from either: (i) the partnership; or (ii) the transferor (provided that the transferor and related persons owned less than a 50 percent interest in capital, profits, deductions, and losses in the partnership in the 12 months before the transfer) based on its most recent Form K-1.

• In certain situations, 10 percent of the amount realized may exceed the amount of proceeds payable by the transferee. In other situations, the transferee may not be able to determine the amount of liability relief to include in the amount realized. In these situations, the Notice provides that, subject to certain limited exceptions, a transferee may withhold the entire amount of proceeds payable to the transferor in satisfaction of its Section 1446(f) withholding obligation.

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Partnership Distributions

• A partnership distribution to a non-U.S. partner in excess of the distributee's basis in its partnership interest is treated as gain from the sale or exchange of a partnership interest, and therefore Section 1446(f) could apply to such a distribution. The Notice provides that a partnership making a distribution to which Section 1446(f) withholding applies may rely on its books and records or request a certificate from the distributee partner to determine the extent to which such distribution exceeds the partner's basis and the amount to be withheld.

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Suspension of Partnership Obligationif Transferee Fails to Withhold

• Section 1446(f)(4) provides that if a transferee fails to withhold under Section 1446, the partnership whose interest is transferred is required to withhold the amount that should have been withheld (plus interest) from subsequent distributions to the transferee. The Treasury Department and the IRS intend to issue implementing regulations; however, the Notice suspends application of Section 1446(f)(4) until such guidance is issued.

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Forms 8804, 8805, and 8813

• Use Forms 8804, 8805, and 8813 to pay and report section 1446 withholding tax based on effectively connected taxable income (ECTI) allocable to foreign partners (as defined in section 1446(e)).

• Use Form 8804 to report the total liability under section 1446 for the partnership's tax year. Form 8804 is also a transmittal form for Form(s) 8805.

• Use Form 8805 to show the amount of ECTI and the total tax credit allocable to the foreign partner for the partnership's tax year.

• Every partnership (other than a publicly traded partnership) that has effectively connected gross income allocable to a foreign partner must file a Form 8804, regardless of whether it had ECTI allocable to a foreign partner. The partnership must also file a Form 8805 for each partner on whose behalf it paid section 1446 tax, regardless of whether the partnership made any distributions during its tax year. The partnership can designate a person to file the forms. The partnership, or person it designates, must file these forms even if the partnership has no withholding tax liability under section 1446.

• Generally, file these forms on or before the 15th day of the 3rd month following the close of the partnership's tax year. For partnerships that keep their records and books of account outside the United States and Puerto Rico, the due date is the 15th day of the 6th month following the close of the partnership's tax year. If the partnership is permitted to file these forms on or before the 15th day of the 6th month, check the box at the top of Form 8804.

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Form 8804

59

Form 8805

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Form 8813

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WSGRGregory P. Broome, Partner - Tax

EXPERIENCE:

Gregory Broome is a partner in the San Francisco office of Wilson Sonsini Goodrich & Sonsini, where his practice focuses on partnership and corporate taxation matters, including significant experience in mergers and acquisitions, initial public offerings, and renewable energy and project development and finance.

Prior to joining the firm, Greg was a partner at Thelen Reid Brown Raysman & Steiner in San Francisco.

REPRESENTATIVE MATTERS:

• Represented KLA Tencor in its merger with Lam Industries

• Represented GoDaddy.com in its acquisition by KKR and Silver Lake Partners and subsequent Up-C IPO

• Represented solar and wind developers (including SunRun and SolarCity) in tax-equity financings using pass-through lease, flip partnership, and sale-leaseback structures

• Structured a $1.3 billion private equity fund focused on the energy sector whose investors consisted of taxable, tax-exempt, and foreign entities; provided advice in connection with the fund's potential equity investment in various renewable and traditional projects

• Structured the purchase and disposition of a biomass-generating facility that involved production tax credits

• Structured a private equity fund's acquisition of a group of companies operating gas-recovery systems with activities expected to generate production tax credits

• Represented a leading power company in the negotiation and sale of preferred-equity partnership interests and the subsequent overall financing of a gas-fired generation project focusing on allocation and distribution

• Represented a leading utility in connection with the $810 million monetization of its communications assets through a leveraged partnership structure

• Represented public-private partnerships in the development, construction, financing, operation, and management of military facilities in South Carolina and Hawaii, including all partnership tax characterization and planning issues

• Represented a leading power company in $1 billion securitization of "in the money" power purchase agreements62

WSGRGregory P. Broome, Partner - Tax

REPRESENTATIVE MATTERS CONT’D:

• Represented a leading power company in connection with its issuance of $1 billion of contingent convertible zero coupon debentures

• Advised the tax-free partnership division of a $3 billion dollar publishing company

• Represented a leading hotel operator in connection with tax-favored financing and 1031 exchanges

EDUCATION:

• J.D., University of California, Berkeley, Boalt Hall School of Law, 1990

• B.A., University of California, Santa Barbara, 1984

SELECT SPEAKING ENGAGEMENTS:

• Greg has spoken at several conferences on the topics of mergers and acquisitions, utility financing, and the use of partnerships and limited liability companies.

ADMISSIONS:

• State Bar of California

• State Bar of New York

• U.S. Tax Court

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I.R.C. § 1446 Withholding Requirements for Foreign Partner’s Effectively Connected Income: Forms 8804 and 8288

Special Rules for Real Estate Partnerships, Partner-Level Adjustments, Overpayment Rules, Remedying Noncompliance

Alison N. Dougherty, J.D., LL.M.Tax Director

Wagner, Duys & Wood, LLLP

https://wagnerduys.com/blog/consider-the-basics-of-u-s-federal-income-tax-reporting-and-compliance-for-foreign-investors-in-u-s-real-property/

https://wagnerduys.com/blog/form-8288-b-may-reduce-a-foreign-investors-firpta-withholding-tax-liability-on-sale-of-a-u-s-real-property-partnership-interest/

https://wagnerduys.com/blog/foreign-investors-in-u-s-real-property-may-reduce-firpta-withholding-tax-liability-by-filing-form-8288-b-exemption-certificate-application/

© 2019 | All Rights Reserved | Alison N. Dougherty |

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsA. Determining what is a U.S. real property interest for purposes of I.R.C. § 897

B. I.R.C. § 1445 withholding requirements on dispositions of U.S. real property interests

C. I.R.C. §§ 864(c)(8)(C) and 897 coordination provisions subjecting certain gains on sale of foreign partnership interests to the Foreign Investment in Real Property Tax Act (FIRPTA) withholding tax provisions rather than treating such gains as ECTI subject to I.R.C. § 1446 withholding tax

D. U.S. federal Forms 8288, 8288-A, and 8288-B

E. Exemptions and Affidavits

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsA. Determining what is a U.S. real property interest for purposes of I.R.C. § 897

I.R.C. § 897(c) definition of U.S. real property interest (USRPI)

1. An interest owned in real property located in the United States or the U.S. Virgin Islands

Includes an interest in a mine, well, or other natural deposit

2. Any interest in a U.S. real property holding corporation (USRPHC)

Does not include an interest solely as a creditor

USRPHC test:

Fair market value of the U.S. corporation’s real property interests equals or exceeds 50 percent of the FMV of U.S. and foreign real property assets and any other trade or business assets

Stock in a publicly traded U.S. corporation with USRPIs only treated as a USRPI if 5% or more held

3. An interest in a U.S. or foreign partnership that owns U.S. real property

I.R.C. § 897(c)(4)(B) – U.S. real property held by a partnership, trust, or estate is treated as owned proportionately by the partners or beneficiaries

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsB. I.R.C. § 1445 withholding requirements on dispositions of U.S. real property interests

I.R.C. § 1445(a) 15% withholding tax applies on foreign person’s disposition of U.S. real property interest (USRPI)

I.R.C. § 1445(c)(4) 10% withholding tax rate may apply if sale of residence with amount realized that does not exceed $1M

I.R.C. § 1445(e)(5) 15% FIRPTA withholding tax applies to the sale of an interest in a U.S. or foreign partnership that owns U.S. real property interests

U.S. Temp. Treas. Reg. § 1.1445-11T(b) and (d)(1) – FIRPTA withholding tax per I.R.C. § 1445(e)(5) applies if:

50% or more of the value of the partnership’s gross assets are USRPIs, and 90% or more of the value of the partnership’s gross assets are USRPIs plus cash or cash

equivalents

FIRPTA withholding tax under I.R.C. §§ 1445(a) and 1445(e)(5) applies to the amount realized

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I.R.C § 1445(e)

1. Gain allocable to foreign person on disposition of USRPI by U.S. partnership, trust, or estate subject to FIRPTA withholding tax at highest U.S. federal corporate tax rate (currently 21%) or 20% as provided in regulations

2. Certain distributions by foreign corporations – Highest U.S. federal corporate tax rate x gain on liquidating distribution, redemption, or nonrecognition transaction where USRPI not exchanged for another taxable USRPI

3. Distributions by U.S. corporations to foreign shareholders 15% x A/R on redemption distribution Return of capital distributions in excess of E&P subject to FIRPTA withholding

but may file claim for exemption under regulations

4. Taxable distributions by U.S. or foreign partnerships, trusts, or estates – 15% x FMV of interest distributed

5. Dispositions of interests in partnerships, trusts, or estates – 15% x Amount Realized

6. Distributions by RICs and REITs - Highest U.S. federal corporate tax rate or 20% as provided in regulations x gain from distribution treated as sale of a USRPI in the hands of the foreign corporation or individual

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I.R.C. 1445(a) Example –

For illustrative purposes, the example focuses on the U.S. federal tax liability. The state and local tax consequences are not addressed. A foreign investor purchases U.S. real property for $7M USD in Year 1. The original $7M purchase price includes $2M of cash and a $5M mortgage liability. The property is held as a rental property. The foreign investor incurs an additional cost of $500K to improve the property. Depreciation on the property is allowed or allowable in the total amount of $300K for the first four years. The foreign investor sells the U.S. real property for $10M USD in Year 4. The foreign seller’s gross sale proceeds include $6M USD of cash and $4M of debt relief, i.e., the mortgage liability assumed by the buyer. The seller’s selling costs are $600K. The foreign seller’s FIRPTA withholding tax liability would be $1.5M USD which is 15% multiplied times the gross sale proceeds of $10M USD. The foreign seller’s gain on the sale is $2.2M USD which is the gross sale proceeds, i.e., the amount realized of $10M USD, less the seller’s adjusted basis of $7.8M USD ($7M original cost + $500K improvements + $600K selling costs - $300K depreciation). For this example, it is assumed that the gain is sourced to a state that does not impose tax on the gain. The U.S. federal tax on the gain is less than the FIRPTA withholding tax liability. It may be possible to file an application for a FIRPTA withholding exemption certificate to pay a reduced amount of FIRPTA withholding tax.


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I.R.C. 1445(e)(5) Example –

For illustrative purposes, the example focuses on the U.S. federal tax liability. The state and local tax consequences are not addressed. A foreign partner’s outside basis is $7M in an interest in a U.S. or foreign partnership that is invested in U.S. real property. The $7M includes $2M attributable to cash capital contributions to the partnership and the foreign partner’s share of net taxable income and loss earned by the partnership over the years since the partnership interest was acquired. The $7M also includes $5M attributable to the foreign partner’s share of the partnership’s mortgage financing liability on the U.S. real property owned by the partnership. Assume that the fair market value of the foreign partner’s partnership interest is $10M attributable to the appreciation in value of the partnership’s assets including U.S. real property. The foreign partner sells the partnership interest for $10M. The gross sale proceeds include $5M of cash and $5M of debt relief from the foreign partner’s share of the partnership’s mortgage financing liability on the U.S. real property assumed by the buyer. The foreign partner’s FIRPTA withholding tax liability is $1.5M which is 15% multiplied times the $10M of gross sale proceeds including the cash and the debt relief from liabilities assumed by the buyer. The foreign partner’s taxable gain is only $3M which is the $10M amount realized from the gross sale proceeds less the $7M outside basis in the partnership interest. Before the IRS issues the proposed regulations under I.R.C. § 1446(f), it may still be possible to file an application for a FIRPTA withholding exemption certificate to pay a reduced amount of withholding tax. Consider the language of IRS Notice 2018-29, Section 10.


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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsC. I.R.C. §§ 864(c)(8)(C) and 897 coordination provisions subjecting certain gains on sale of foreign partnership interests to the Foreign Investment in Real Property Tax Act (FIRPTA) withholding tax provisions rather than treating such gains as ECTI subject to I.R.C. § 1446 withholding tax

I.R.C. § 864(c)(8) and Proposed Regulations [REG-113604-18]: Gain from the sale of an interest in a partnership with U.S. real property interests is treated as effectively connected with a U.S. trade or business

I.R.C. § 864(c)(8) applies to tiered partnership structures (look to lowest tier)

Prop. Reg. § 1.897-7(c) provides coordination between I.R.C. §§864(c)(8) and 897(g)

I.R.C. § 897(g) applies FIRPTA to sales of partnership interests by foreign persons

I.R.C. § 1445(e)(5) applies FIRPTA withholding to sales of partnership interests under I.R.C. § 897(g)

I.R.C. § 1446(f) requires U.S. federal withholding tax at 10% on amount realized from sale of partnership interest by a foreign person

IRS Notice 2018-29 – I.R.C. § 1445(e)(5) FIRPTA withholding controls

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsC. I.R.C. §§ 864(c)(8)(C) and 897 coordination provisions subjecting certain gains on sale of foreign partnership interests to the Foreign Investment in Real Property Tax Act (FIRPTA) withholding tax provisions rather than treating such gains as ECTI subject to I.R.C. § 1446 withholding tax

IRS Notice 2018-29, Section 10 - Coordination of I.R.C. §§1446(f) and 1445(e)(5) withholding provisions If both withholding provisions apply, then FIRPTA

withholding governs. Exception if FIRPTA withholding exemption certificate

obtained then the transferee of the partnership interest must withhold the greater of the amounts required under I.R.C. § 1446(f) or 1445(e)(5)

Regulations not yet issued under I.R.C. § 1446(f) Issue whether IRS may put an end to the advantage of a

FIRPTA withholding exemption certificate for sales of partnership interests

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsD. U.S. federal Forms 8288, 8288-A, and 8288-B

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsD. U.S. federal Form 8288

Form 8288 U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests Part I reports information for buyer or other transferee required to

withhold under I.R.C. § 1445(a). Line 1 reports the buyer’s name, address, FEIN, SSN or ITIN. Line 2 reports the description and location of the property acquired. Line 3 reports the date of the transfer. Line 4 reports the number of Forms 8288-A attached. Line 5 reports the amounts subject to FIRPTA withholding at 10% or

15%. Box to check for withholding at a reduced rate. Line 6 reports the total amount withheld. Part II reports information for buyer or other transferee required to

withhold under I.R.C. § 1445(e). Same information as Part I is reported in Part II. Additional 21% FIRPTA withholding tax rate category in Part II Box to check for large trust election to withhold at distribution

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsD. U.S. federal Form 8288-A

Form 8288-A Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests The buyer is the withholding agent. The buyer files the Forms 8288 and 8288-A with the IRS. The Form 8288-A is like a Form 1099 or 1042-S. Form 8288 reports the buyer’s and seller’s information including

name, FEIN, SSN or ITIN, and address. Box 1 reports the date of transfer. Box 2 reports the U.S. federal income tax withheld. Box 3 reports the amount realized. Box 4 reports any gain recognized by a foreign corporation. Box 5 reports the description of the property transferred.. Box 6 reports the type of foreign person subject to FIRPTA

withholding (foreign corporation, individual, or other foreign person). Box 7 reports the country code of the foreign person subject to

FIRPTA withholding tax. Withholding agent files Copy A with IRS, foreign person subject to

withholding files copy B with IRS, Copy C for withholding agent.

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsD. U.S. federal Form 8288-B

Form 8288-B Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests Line 1 reports transferor’s, i.e., the seller’s information. Line 2 reports transferee’s, i.e., the buyer’s information. Line 3 indicates whether the transferor or the transferee is the applicant. Line 4a reports the withholding agent’s information. Line 4c reports the name of the estate, trust, or entity, if applicable. Line 5 reports the address where the IRS will send the exemption certificate. Line 6 reports information about the sale of the property including the date of

transfer, contract price, adjusted basis, location and description of the property, use of the property, whether U.S. income tax returns were filed and U.S. tax was paid.

Line 7 reports the reason why the exemption certificate should be issued (exempt due to nonrecognition, final tax liability less than withholding, installment sale).

Line 8 reports whether transferor has any unsatisfied withholding tax liability. Line 9 reports indicates what section of I.R.C. § 1445(e) the application is based

on and who is the applicant. IRS processing time for Form 8288-B is approximately 90 days. FIRPTA withholding tax deposit due within 20 days of closing date of the sale.

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsE. Exemptions and Affidavits

I.R.C. § 1445(b) Exemptions

1. Transferor furnishes nonforeign affidavit

2. Nonpublicly traded U.S. corporation furnishes affidavit that interests in corporation are not USRPIs

3. Transferee receives qualifying statement from IRS

4. Residence where amount realized does not exceed $300,000 USD

5. Stock regularly traded on established securities market

6. Applicable wash sale transactions

U.S. Temp. Treas. Reg. § 1.1445-11T(d)(2) - Transferee receives statement that partnership interest is not described in § 1.1445-11T(d)(1) where 50% or more of value of partnership’s gross assets are USRPIs and 90% or more of value of partnership’s gross assets are USRPIs plus cash or cash equivalents

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IV. Rules and Requirements Specific to U.S. Real Estate HoldingsE. Exemptions and Affidavits

U.S. Temp. Treas. Reg. § 1.1445-11T(d)(2) – Transferee statement Issued by the partnership and signed by the general partner under penalties of perjury No earlier than 30 days before the transfer Certifying that 50% or more of the value of the partnership’s gross assets does not consist

of USRPIs and 90% or more of the value of the partnership’s gross assets does not consist of USRPIs plus cash or cash equivalents

Cash equivalents include any asset readily convertible into cash in U.S. or foreign currency, bank accounts, certificates of deposit, money market accounts, commercial paper, U.S. and foreign treasury obligations and bonds, corporate obligations and bonds, precious metals or commodities, and publicly traded instruments

Transferee cannot rely on statement if knowledge that it is false or receives notification from transferee’s or transferor’s agent that it is false

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ALISON N. DOUGHERTY, J.D., LL.M. TAX DIRECTORWAGNER, DUYS & WOOD, LLLP

Alison N. Dougherty provides tax services as a Tax Director at Wagner, Duys &Wood, LLLP. Alison specializes in U.S. tax reporting, compliance, consulting,planning, and structuring for real estate partnerships and U.S. blockercorporations with foreign investors. She works closely with nonresidentindividuals and businesses regarding inbound U.S. real property investment. Shehas significant experience with U.S. Federal nonresident withholding tax, foreignpartner withholding tax, and FIRPTA withholding tax.

Alison has also worked extensively in the area of U.S. international tax reportingand compliance with the preparation of the U.S. Federal Forms 5471, 926, 8865,8858, 5472, 1042, 1042-S, 8621, 8804, 8805, 8813, 8288, 8288-A, 8288-B, 1116,1118, 1120-F, 1040-NR, 3520, 3520-A, 2555, 5713, 8832, 8833, 8840, 8843,8854, 8938, and FBAR.

Alison completed the LL.M. (Master of Laws) in Securities and FinancialRegulation in 2004 with academic distinction at Georgetown University LawCenter. She completed the LL.M. (Master of Laws) in Taxation in 2000 and theJuris Doctor in 1999 at the University of Denver College of Law. She completeda Bachelor of Arts degree in Foreign Language in 1995 at VirginiaCommonwealth University.

Direct (301) 284-0907 [email protected], Duys & Wood, LLLP4550 Montgomery AvenueSuite 315 NorthBethesda, Maryland USA 20814Washington, DC Metro Areahttps://wagnerduys.com

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