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June 25, 2019

Proposed Regs Clarify How Partnerships Withhold Taxes On Behalf of Certain Foreign Partners

Certain Foreign Partners

New IRS guidance may help partnerships understand their withholding tax requirements. The new tax law commonly known as the Tax Cuts and Jobs Act (TCJA) changed the way certain partnerships were required to withhold tax, but like many of the TCJA changes, the rules needed clarification.

The TCJA included an obscure provision that affects foreign partners of domestic partnerships. Under Internal Revenue Code (IRC) Section 864(c)(8), foreign partners of both U.S. partnerships and foreign partnerships that do business in the U.S. may now incur a U.S. tax liability when they sell their partnership interests.

Two recent IRS notices – Notice 2018-08 and Notice 2018-29 – helped taxpayers and partnerships interpret this new law, but the notices stopped short of addressing another important facet: tax withholding. On May 7, 2019, the IRS released proposed regulations that clarify when partnerships should withhold taxes (and in what amounts) on behalf of their partners who sell all or part of their partnership interests.

Background on Withholding Requirement – Section 1446(f)

Section 1446 requires partnerships to withhold tax on certain income allocable to foreign partners. Additionally, the TCJA now imposes a 10% withholding tax on the amount realized by foreign partners from the sale, exchange, or taxable disposition of applicable partnership interests at a gain. Specifically, the transferee is primarily liable under Section 1446(f) to withhold this 10%  tax from the amount the transferee pays to the transferor if any portion of the transferor’s gain on disposition would be treated as “effectively connected income” (ECI) under Section 864(c)(8). The partnership is the backstop to a transferee’s failure to withhold on such a transaction, in which case the partnership must withhold against any distributions it subsequently makes to the transferee – plus interest.

When the partnership makes a distribution to a foreign partner that results in a similar type of gain, the partnership is treated as the transferee under Notice 2018-29, and is thus the exclusive party liable for the withholding tax in that circumstance. In any case, when the partnership is subject to the withholding tax, the May 2019 proposed regulations help partnerships determine the amount to withhold.

Proposed Regulations – Withholding Tax

The IRS’s proposed regulations address two of the main concerns surrounding the Section 1446(f) withholding calculation:

  • How to calculate the amount that should be withheld, and
  • Exceptions to the withholding requirements.

Calculating Withholding

Foreign partners may be subject to U.S. taxation when they recognize gains on the disposition of their partnership interests. Interestingly, the 10% withholding tax is not calculated with reference to the transferor partners’ gains; instead, the tax is based on the “amount realized” by the transferor in such transactions. The amount realized from dispositions is determined under typical gain calculation rules, which means that it includes the following:

  • Cash paid (or to be paid);
  • Fair market value of property received (or to be received); and,
  • Liabilities assumed (or to be assumed) by the purchaser.

When the amount realized is heavily weighted with assumption of liabilities, the withholding amount may exceed the value of cash or property the transferor received, which can make the transaction much less appealing to the transferring partner. The IRS did not provide any relief from this dilemma. Consider the following example: 

Foreign partner X sell his partnership interest to domestic partner Y for $100 cash, $700 of property, and $20,000 in assumed liabilities.

Amount Realized:
 $100 cash
  $700 property
+ $20,000 reduction in liability


Withholding Amount:

$20,800 amount realized
X 10 percent

In lieu of paying X the money and giving him the property, Y, the transferee, could use the $100 of cash and the $700 of property he owes X to pay a portion of Y’s $2,080 withholding requirement; however, Y would then have to get an additional $1,280 from X to make up the difference.

As a result, in selling his partnership interest, X would receive no cash and no property, and he would actually owe Y money to pay the withholding tax due. As noted previously, (a) if Y fails to pay the withholding then the partnership must withhold from any distributions due to Y after the transfer, and (b) if the partnership makes a distribution resulting in gain, the partnership is treated as the transferee, resulting in the same treatment as if there had been a sale between the partnership and the transferor partner.

The IRS, in the explanation of the proposed regulations, set forth the reporting obligations for both the transferee and the partnership:

D. Reporting and Paying Withheld Amounts


A transferee required to withhold must report and pay any tax withheld by the 20th day after the date of the transfer. See Proposed § 1.1446(f)-2(d)(1). To report and pay the amount withheld, the proposed regulations direct the transferee to use Forms 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests, and 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests. The IRS will stamp a valid Form 8288-A to show receipt and mail a copy to the transferor.


As discussed above, a partnership must withhold on distributions to a transferee under Section 1446(f)(4) to the extent the transferee fails to properly withhold under Section 1446(f)(1) and Proposed § 1.1446(f)-2(a). See Proposed § 1.1446(f)-3. In order for the partnership to determine whether it must withhold under these rules, Proposed § 1.1446(f)-2(d)(2) requires a transferee to timely furnish certain information regarding its compliance with Section 1446(f)(1) to the partnership.

Specifically, Proposed § 1.1446(f)-2(d)(2) requires a transferee (other than a partnership that is a transferee because it makes a distribution) to furnish, no later than 10 days after the transfer, a certification to the partnership that either includes a copy of the Form 8288-A that it files with the IRS, or states the amount realized on the transfer and any amount withheld by the transferee. The certification must also include any underlying certifications that the transferee has relied upon that claim an exception or adjustment to withholding. … [T]he partnership must conduct its own review of the certification provided by the transferee, including any underlying certifications. Therefore, a transferee that has relied on a certification claiming an exception or adjustment to withholding may want to ensure that the partnership has determined the certification to be correct and reliable before the due date for payment of any withheld amounts to the IRS.

The same explanatory provisions also emphasize that a transferee who fails to withhold and pay the tax due may be liable for penalties, even if the partnership subsequently pays the withholding tax and interest from distributions otherwise due the transferee:

“Proposed § 1.1446(f)-5(a) provides that every person required to deduct and withhold tax under section 1446(f), including under proposed §§ 1.1446(f)-2 through 1.1446(f)-4, but that fails to do so is liable under section 1461. If the tax required to be withheld is paid by another person required to withhold, or by the nonresident alien individual or foreign corporation subject to tax under section 864(c)(8), section 1463 and the proposed regulations clarify that the tax will only be collected once. However, the satisfaction of this liability does not relieve a person that failed to withhold under section 1446(f) from any interest, penalties, or additions to tax that would otherwise apply.”

The interaction of the withholding determination based upon amount realized, along with reporting obligations and potential penalties, all combine to create traps for sellers and buyers of partnership interests held by foreign partners, as well as their advisors.


Six exceptions to these withholding requirements are permitted. Under five of these six exceptions, the partnership does not need to withhold any taxes if the transferring partner can certify one of the following conditions:

  • He or she is not a foreign person.
  • He or she will recognize a loss (rather than a gain) on the sale of his or her partnership interest.
  • He or she is not required to recognize gain pursuant to a non-recognition provision.
  • He or she is not required to recognize gain pursuant to an income tax treaty.
  • During the most recent three years, (1) he or she was a partner in the partnership; (2) the share of “effectively connected income” (ECI) was less than 10% of his or her distributive share of the partnership’s net income; and (3) he or she reported and paid tax on his or her ECI.

Under the final exception, there is no withholding tax applicable if the partnership can certify that the amount of gain resulting from all foreign partners’ ECI would be less than 10% of the gain that would result from the partnership’s sale of all of its assets at fair market value on the date of transfer.

Previously under Notice 2018-08, publicly traded partnerships were not obligated to comply with the withholding requirements of Section 1446(f), but the proposed Treasury Regulations reverse this decision. If the proposed regulations are finalized without changes, publicly traded partnerships must follow the same rules as non-publicly traded partnerships.

Effective Dates

Until the proposed regulations are finalized, taxpayers may rely on Notices 2018-08 and 2018-29 to comply with the TCJA with regard to a foreign partner’s sale or exchange (including taxable distributions) of a partnership interest. Notice 2018-29 includes many of the same withholding provisions in the proposed regulations, but it only applies to non-publicly traded partnerships.

If the proposed regulations are finalized in their present form, both publicly traded and non-publicly traded partnerships should apply the withholding provisions (when a transferee fails to withhold or is otherwise not involved in the transaction) to transfers of their foreign partners’ partnership interests that occur 60 days or more after the date the final regulations are published.

These new withholding provisions were created to help the IRS enforce the collection of taxes imposed by Section 864(c)(8), so we do not expect the withholding burdens to diminish in the final regulations. The IRS’s final regulations are expected in the very near future.

If you have any questions about the new withholding tax requirements, contact us.

Related Reading

2019 Business Tax Planning Supplement

Copyright © 2019, CBIZ, Inc. All rights reserved. Contents of this publication may not be reproduced without the express written consent of CBIZ. This publication is distributed with the understanding that CBIZ is not rendering legal, accounting or other professional advice. The reader is advised to contact a tax professional prior to taking any action based upon this information. CBIZ assumes no liability whatsoever in connection with the use of this information and assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect the information contained herein.

CBIZ MHM is the brand name for CBIZ MHM, LLC, a national professional services company providing tax, financial advisory and consulting services to individuals, tax-exempt organizations and a wide range of publicly-traded and privately-held companies. CBIZ MHM, LLC is a fully owned subsidiary of CBIZ, Inc. (NYSE: CBZ).

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