Many of the provisions in the Tax Cuts and Jobs Act (TCJA) will have significant impact on individual taxpayers as well as all types of tax entities, including partnerships and limited liability companies (LLCs). However, there are some provisions of the TCJA that will only impact partnerships and LLCs that are taxed as partnerships. This update is the next in a series that address those specific provisions in greater detail. See the previous updates about the new three-year holding period for certain carried interests and the repeal of the partnership technical termination rule and basis adjustments for charitable contributions and foreign taxes.
U.S. Withholding on Foreign Partner’s Disposal of Interest in Partnership
In addition to the codification of Revenue Ruling 91-32, clarifying that a non-U.S. partner’s gain or loss on the disposal of their partnership interest is subject to U.S. taxation to the extent the partnership holds any ECI-generating assets, a new U.S. withholding requirement also applies to such disposals. The TCJA requires the buyer to now withhold and remit 10% of the gross purchase price, including the seller’s allocated share of any partnership liabilities, for an interest in a partnership (or LLC taxed as a partnership) if the partnership conducts a trade or business in the U.S. An exception to this new withholding requirement applies if the seller/transferor certifies that either (a) they are not a nonresident alien or a foreign corporation or (b) no portion of the seller’s gain is attributable to ECI-generating assets. Although not specifically stated in the legislation, this withholding requirement may apply not only to a sale of a partnership interest by a foreign person but also to a redemption of a partnership interest that is held by a foreign person.
If the buyer fails to withhold and remit the mandatory 10% federal tax, the partnership itself will be liable for the withholding tax, plus interest. Therefore, partnerships should consider means of minimizing their liability, including obtaining proof of appropriate withholding and amending their operating agreements to require indemnification for any amounts the partnership is required to pay.
The IRS has already issued a notice suspending this new withholding requirement on the sale or exchange of publicly traded partnership interests until additional guidance is issued. However, the 10% withholding is still required on the sale or exchange of privately held partnership interests. Fortunately, the IRS did provide some interim guidance to assist privately held partnerships and their partners to comply with this new rule until regulations are issued. The notice includes exemptions for non-recognition transactions and de minimis ECI, the determination of the selling partner’s share of allocated partnership liabilities, a discussion of the application of these rules when a non-U.S. partner receives a distribution that exceeds the partner’s outside basis in its partnership interest, acceptable forms of affidavits, procedural aspects of collecting and remitting the withholding tax, and information on the application of these rules to tiered partnerships. See Notice 2018-29 for further details.
This new withholding tax requirement is effective only for dispositions after December 31, 2017.