PARTNERSHIPS that do business in the United States must withhold income taxes on US income that is allocated to any foreign partners.
The withholding is not on cash distributed to the foreign partners, but on the income allocated to them. For example, if a partnership earns $100 in a year and $25 of it is allocated to a foreign partner, then even if no cash is distributed that year to the partner, the partnership must withhold and pay over to the IRS tax at the highest US rate on the $25. The foreign partner receives a credit for the taxes paid on his behalf that he can claim against any US taxes he might otherwise owe — assuming he files a US tax return.
The IRS issued proposed regulations in September to implement these rules. The withholding is only on income that is considered “effectively connected” to a US trade or business of the partnership. Under the proposed regulations, a partnership must receive a Form W-8BEN, Form W-81MY or Form W-9 from each of its partners revealing its status. It must assume any partner from whom it does not receive such a form is a foreigner and withhold taxes, unless it has proof from other sources that the partner is a US person.
The partnership will be held accountable if its “proof” proves incorrect.