Sales of partnership interests and “excess” cash distributions by US partnerships to foreign persons require US tax withholding after the latest overhaul of the US tax code.
Withholding at a 10% rate on the “amount realized” by the foreign person is required on sales of partnership interests and excess cash distributions on or after January 1 this year.
The idea is to help the IRS collect US tax on foreign sellers who may be hard to track down or audit later.
There is a presumption that every partner is a foreign person unless he certifies to the contrary. Thus, even in purely US deals, it is important to get certificates.
The person buying the partnership interest must withhold part of the purchase price. Failure to do so obligates the partnership to withhold future cash distributions to the buyer, after the buyer becomes a partner, until the tax debt, including interest for late payment, has been paid.
A cash distribution is an “excess” distribution to the extent it exceeds the “outside basis” a partner has in its partnership interest. Partnerships use two metrics to track what each partner put into the partnership and is able to take out. One is called “outside basis.” Once the outside basis reaches zero, then any further cash distributions to the partner are treated as “excess” distributions and must be reported as capital gain.
Withholding is required by section 1446(f) of the US tax code.
The IRS has suspended such withholding by master limited partnerships whose units are publicly traded, pending future guidance. It is harder to track sellers in such partnerships.
The agency said in a notice in early April that there will be no delay for other partnerships.
However, it said no withholding is required in five situations. The notice is Notice 2018-29.
Withholding is not required if the seller or partner receiving cash distributions certifies in writing that it is not a foreign person.
Withholding is not required if the seller certifies that it does not have a gain.
It is not required if the seller certifies that less than 25% of its total income from the partnership in each of the last three years was “effectively connected” with a US trade or business. This would be relevant in a US partnership with significant foreign assets.
Withholding is not required if the partnership certifies that less than 25% of the gain from a sale of all its assets would be effectively connected with a US trade or business.
The 25% thresholds are expected to be reduced eventually by the IRS when it issues formal regulations.
The “amount realized” by someone selling a partnership interest includes the partner’s share of debt at the partnership level and other debt to which the interest is subject directly, such as back-levered debt at the partner level. In some cases, the share of debt may exceed the cash received from the sale. Where that happens, no withholding is required beyond the cash sales proceeds for now, but this is likely to change when IRS regulations are issued.