If you have a foreign partner in your partnership, you may need to pay a withholding tax on that partner. A partnership that has income effectively connected with a U.S. trade or business is required to pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners. A foreign partner is anyone who is not considered a U.S. person. This includes nonresident aliens, foreign corporations, foreign partnerships, and foreign trusts or estates.
The partnership must pay the withholding tax regardless of the foreign partner’s ultimate U.S. tax liability for the year and even if the partnership did not make any distributions during the year. The amount of withholding tax is the highest tax rate at that time (37% and 21% for individuals and corporations, respectively, in 2018). The effectively connected taxable income is income that is effectively connected to a U.S. trade or business. Generally speaking, not effectively connected U.S. source income (fixed, determinable, annual and periodic) should be withheld on a gross basis at 30% unless the treaty provides for a reduction in this amount.
The partnership agreement should be reviewed to determine the allocable amount to each partner. Each foreign partner will have his equity account adjusted to reflect the applicable tax payment remitted on his behalf. These payments are then reported on the foreign partner’s U.S. income tax return and will offset the U.S. tax liability ultimately assessed on him personally.
The withholding tax must be paid on a quarterly basis, before the fifteenth day of the fourth, sixth, ninth, and twelfth months of the partnership’s tax year. Therefore, the partnership should review the allocable foreign partner’s share of taxable income throughout the year and pay the withholding tax accordingly to avoid any penalties at year end.
Jill A. Helm, CPA