Partnership Withholding on Effectively Connected Income A partnership (foreign or domestic) that has income effectivelyconnected with a U.S. trade or business (or income treated aseffectively connected) must pay a withholding tax on the effectivelyconnected taxable income that is allocable to its foreign partners. Apublicly traded partnership must withhold tax on actual distributionsof effectively connected income, unless it chooses to withhold underthese rules. See Publicly Traded Partnerships, later. This withholding tax does not apply to income that is noteffectively connected with the partnership's U.S. trade or business.That income is subject to withholding tax at 30%, or a lower treatyrate, as discussed earlier in this publication. Who Must Withhold The partnership, or a withholding agent for the partnership, mustpay the withholding tax. A partnership that must pay the withholdingtax but fails to do so, may be liable for the payment of the tax, andany penalties and interest. Foreign Partner The partnership must determine whether a partner is a foreignpartner. 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 non-foreignstatus and assume that a partner is not a foreign partner if thepartner provides a certification to the partnership that: States that the partner is not a foreign person, Gives the partner's name, U.S. taxpayer identificationnumber, and address, States that the partner will notify the partnership within60 days of a change to foreign status, and Is signed under penalties of perjury. Sample certifications are contained in section 5.04 of RevenueProcedure 89-31, 1989-1 C.B. 895. The partnership must keep the certification 5 years after the lasttax 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: The third year, after the partnership's tax year in whichthe certification was made, ends, The partner notifies the partnership that it has become aforeign partner, or The partnership learns that the partner is a foreignpartner. Widely held and publicly traded partnerships.A partnership with more than 200 partners or a publicly tradedpartnership may rely on statements received on Form 1001, FormW-8, or Form W-9 in lieu of the above certification. Itmay also rely on a certification from a nominee that a partner owninga partnership interest through the nominee is not a foreign partner.In this situation, the nominee may rely on a partner's certificationof non-foreign status as described earlier, or it may rely onstatements provided it on Forms 1001, W-8, or W-9. Amount of Withholding Tax The withholding tax that a partnership must pay for thepartnership's tax year is based on its effectively connected taxableincome that is allocable to its foreign partners for that tax year. The amount of a partnership's effectively connected taxable incomethat is allocable to a foreign partner is the foreign partner'sdistributive share of the partnership's gross effectively connectedincome reduced by the partner's distributive share of partnershipdeductions for the year. For information on effectively connectedincome and how to figure a partner's distributive share of income anddeductions, see the Instructions for Forms 8804, 8805, and 8813. A partnership must make installment payments of withholding tax onits foreign partners' share of effectively connected taxable incomewhether or not distributions are made during the partnership's taxyear. Tax rate.The withholding tax rate on a partner's share of effectivelyconnected income is 35% for a partner taxed as a corporation, and39.6% for all other partners, such as individuals, partnerships, andestates. Amount of installment payment.The amount of a partnership's installment payment is the sum of theinstallment payments for each of its foreign partners. The amount ofeach foreign partner's installment payment of withholding tax can befigured by using the worksheet in the Instructions for Forms8804, 8805, and 8813. Date payments are due.Payments of withholding tax must be made during the partnership'stax year in which the effectively connected taxable income is derived.A partnership must pay the IRS a portion of the annual withholding taxfor its foreign partners by the 15th day of the 4th, 6th, 9th, and12th months of its tax year for U.S. income tax purposes. Anyadditional amounts due are to be paid with Form 8804, the annualpartnership withholding tax return. A foreign partner's share of withholding tax paid by a partnershipis treated as distributed to the partner on the earliest of: The day on which the tax was paid by the partnership, The last day of the partnership's tax year for which the taxwas paid, or The last day on which the partner owned an interest in thepartnership during that year. Real property gains.If a domestic partnership disposes of a U.S. real propertyinterest, the gain is treated as effectively connected income and thepartnership or withholding agent must withhold following the rulesdiscussed here. A domestic partnership's compliance with these rulessatisfies the requirements for withholding on the disposition of U.S.real property interests (discussed later). This also applies topublicly traded partnerships that elect to withhold based oneffectively connected income instead of on actual distributions asdiscussed later. Reporting andPaying the Tax Three forms are required for reporting and paying over tax withheldon 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 taxyear is reported on Form 8804. Form 8804 is also a transmittal formfor Forms 8805. Any additional withholding tax owed for the partnership's tax yearis paid to the IRS (in U.S. currency) with Form 8804. A Form 8805 foreach foreign partner must be attached to Form 8804, whether or not anywithholding tax was paid. The Form 8804 is not filed as part of Form1065, U.S. Partnership Return of Income. File Form 8804 by the 15th day of the 4th month after the close ofthe partnership's tax year. However, a partnership made up of allnonresident alien partners has until the 15th day of the 6th monthafter the close of the partnership's tax year to file. If you needmore time to file Form 8804, you may file Form 2758 to request anextension. Form 2758 does not extend the time to pay the tax. Form 8805,Foreign Partner's Information Statement of Section 1446Withholding Tax. Form 8805 is used to show the amount ofeffectively connected taxable income and any withholding tax paymentsallocable to a foreign partner for the partnership's tax year. At theend of the partnership's tax year, Form 8805 must be sent to eachforeign partner whether or not any withholding tax is paid. It shouldbe delivered to the foreign partner by the due date of the partnershipreturn (including extensions). A copy of Form 8805 for each foreignpartner 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 Form1120-F. Form 8813,Partnership Withholding Tax Payment (Section 1446). Thisform is used to make payments of withheld tax to the IRS. Paymentsmust be made in U.S. currency by the payment dates (see Datepayments 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 1042discussed 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 correctinformation. The amount of the penalty depends on when you file acorrect Form 8805. The penalty for each Form 8805 is: $15 if you file a correct form within 30 days, with amaximum penalty of $75,000 per year ($25,000 for a small business),or $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 smallbusiness). A small business is a business that has average annualgross receipts of not more than $5 million for the most recent 3 taxyears (or for the period of its existence, if shorter) ending beforethe calendar year in which the Forms 8805 are due. If you fail to provide a complete and correct Form 8805 to eachpartner, a penalty of $50 for each failure may be imposed. The maximumpenalty is $100,000 per year. If you intentionally disregard the requirement to report correctinformation, the penalty for each Form 8805 is the greater of $100 or10% of the total amount of the items that must be reported, with nomaximum penalty. Identification numbers.A partnership that has not been assigned a U.S. identificationnumber (Employer Identification Number) must obtain one. If a numberhas not been assigned by the due date of the first withholding taxpayment, the partnership should enter the date the number was appliedfor on Form 8813 when making its payment. As soon as the partnershipreceives its identification number, it must immediately provide thatnumber to the IRS. To ensure proper crediting of the withholding tax when reporting tothe IRS, the partnership must include each partner's U.S.identification number on Form 8805. If there are partners in thepartnership without identification numbers, the partnership shouldinform them of the need to get a number. Publicly Traded Partnerships A publicly traded partnership that has effectively connectedincome, gain, or loss, must pay withholding tax on any distributionsof that income made to its foreign partners. In this situation, apublicly traded partnership must use Forms 1042 and 1042-S(Income Code 27) to report withholding from distributions. The rate ofwithholding is 39.6%. A publicly traded partnership is any partnership an interest inwhich is regularly traded on an established securities marketregardless of the number of its partners. This does not include apublicly traded partnership treated as a corporation under section7704 of the Internal Revenue Code. Foreign partner.The partnership determines whether a partner is a foreign partnerusing the rules discussed earlier under Foreign Partner. Election to withhold on effectively connected taxable income.A publicly traded partnership can elect to pay a withholding tax onits effectively connected taxable income allocable to foreign partnersinstead of on its actual distributions. The partnership makes thiselection by filing Forms 8804, 8805, and 8813 and by complying withthe payment and reporting requirements for those forms, as discussedearlier. Once the election has been made, it cannot be revoked withoutthe consent of the IRS. Distributions subject to withholding.If the election to withhold on effectively connected taxable incomeis not made, the partnership must withhold tax on any actualdistributions of money or property to foreign partners. In the case ofa partnership that receives a partnership distribution from anotherpartnership (a tiered partnership), the distribution also includes thetax withheld from that distribution. If the distribution is in property other than money, thepartnership cannot release the property until it has enough funds topay over the withholding tax. A publicly traded partnership that complies with these withholdingrequirements satisfies the requirements discussed later underU.S. Real Property Interest. Distributions subject towithholding include: The fair market value of U.S. real property interestsdistributed to a partner and potentially subject to withholding undersection 1445(e)(4), Amounts subject to withholding under section 1445(e)(1) ondistributions pursuant to an election under section1.1445-5(c)(3) of the regulations, and Amounts not subject to withholding under section 1445because the distributee is a partnership or is a foreign corporationthat has made an election to be treated as a domesticcorporation. Excluded amounts.Partnership distributions are first considered to be paid out ofthe following types of income in the order listed. To the extent thepartnership has this type of income, it is excluded from thedistributions discussed here. Amounts of noneffectively connected income distributed bythe partnership and subject to the 30% withholding tax discussedearlier in this publication. Amounts attributable to recurring dispositions of crops andtimber that are subject to withholding under section1.1445-5(c)(3)(iv) of the regulations. Amounts attributable to the disposition of a U.S. realproperty interest subject to the withholding rules discussed nextunder U.S. Real Property Interest. For more information about the withholding requirements forpublicly traded partnerships, get Revenue Procedure 89-31,1989-1 C.B. 895.