Although a U.S. partnership does not pay U.S. income tax, the partnership issues a Schedule K-1 to each partner annually to report the partners’ share of net income, loss, credits and other items. The foreign partners report these items on their individual U.S. Nonresident Alien Income Tax Return, Form 1040-NR.

A situation frequently arises when a U.S. partnership sells U.S. real property. Assuming no other income, expenses, deductions or credits, sales of U.S. real property are subject to U.S. income tax when sold at a gain. When the U.S. real property is held in a U.S. partnership with foreign partners, this gain is passed through to the foreign partners, and the foreign partners report this gain on their individual U.S. Nonresident Alien Income Tax Return, Form 1040-NR.

In Addition, the U.S. partnership generally needs to make a withholding tax payment on behalf of the foreign partners on Form 8813. The foreign partners when filing their Form 1040-NR will then take a credit for the tax paid on their behalf by the partnership against any tax due on their share of the gain on the sale of the U.S. real property.

The amount of the withholding tax is the applicable percentage of the ECTI ( Effectively Connected Taxable Income) that is allocable to the foreign partners and depends on the corporate or noncorporate status of the foreign partner. For this purpose, the applicable percentage is the highest U.S. tax rate to which each foreign partner is subject.

The Form 8813 is to be filed on or before the 15th day of the 4th, 6th, 9th, and 12th months of the partnership’s tax year for U.S. income tax purposes. For a calendar year partnership, this is the 15th day of April, June, September and December. If, for example, the property is sold on May 1, the payment and Form 8813 should be filed by June 15. Generally, the U.S. partnership must notify each foreign partner of the withholding tax paid on the partner’s behalf within 10 days of making the quarterly payment.

Therefore, it is the U.S. partnership’s obligation to compute the gain on the sale of the U.S. real property in a timely manner, compute the withholding tax, and remit to IRS in a timely fashion based on the aforementioned due dates.

Additionally, the partnership will need to file Form 8804, Annual Return for Partnership Withholding Tax (Section 1446), and Form 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax.

If the withholding payments and filings mentioned above are not completed in a timely manner, the IRS will assess penalties and interest which may be substantial.

Fonte: Mitchell Mossman, CPA, CGMA, MBA – Mossman Advisory Group, LLC

Corporations formed in the United States (including LLC’s that have filed a check the box election to be taxed as a corporation) have a distinct disadvantage with regard to pass through structures such as an LLC taxed as a partnership or as disregarded entity for income tax purposes. Distributions of profits in the form of dividends are subject to a second level tax. If the shareholder is a foreigner the distribution is subject to a withholding tax of 30% at the source. This rate may be reduced if there is a tax treaty between the US and the country of residence of the shareholder (Neither Brazil nor BVI have such treaty). Thus, the corporation pays tax on its net income and the shareholder pays an additional tax on the distribution of dividends from the corporation to its foreign shareholders. In Brazil, this is not currently the case since there is no second-level tax imposed on dividends.

Clients have asked if this tax in the U.S. can be avoided if the distribution is characterized as a return of capital rather than a distribution of profits. The short answer is that if the corporation has “earnings and profits” retained in its financial statements, then the distribution is deemed to be a dividend for US tax purposes up to the amount of the retained earnings and profits. For example, US corporation (“USCO”)has paid-in capital in the amount of $1,000,000. During the year, the USCO had net operating income of $100,000. It paid US federal tax on that income in the amount of 21% thereby leaving a balance of $79,000. Any return of capital to the shareholder up to $79,000 shall be deemed a dividend distributed taxed in the additional amount of $23,700 leaving a net amount of $55,300. That is an effective tax of approximately 45%! The dividend paid is not a deductible expense of USCO.

How to avoid this high taxation in a corporate setting? First, the use of debt from the shareholder to USCO allows the payment of interest to the shareholder. The interest paid is subject to the 30% withholding tax as well but the interest is a deductible expense for USCO. Second, if all earnings and profits are retained in USCO until the liquidation of USCO, all monies distributed to the shareholder are not subject to this second level of tax. Thus, many clients will allow the monies to accumulate in USCO or reinvest the same until dissolution.

These issues related to taxation of distributions from corporations is why clients should consider “pass-through” structures that eliminate the second level of tax discussed above. This will be examined in next month’s newsletter.

Nelson Slosbergas