THE INTERNATIONAL TAX ADVISOR

by:  Douglas J. Kingston, CPA/MBA  • Mailing Address: 16443 N 59th Place; Scottsdale, AZ 85254

• Telephone: +1 (602) 595-5885 (GMT-7) • E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/

FIRPTA WITHHOLDING TAX - BUSINESS ENTITIES WITH FOREIGN OWNERS

 

Background

 

 

Partnership With a Foreign Partner

 

 

Trust or Estate With a Foreign Owner or Beneficiary

 

 

Distribution of USRPI by a Foreign Corporation

 

 

Distribution of USRPI by Certain Domestic Corporations

 

 

Transactions Exempt from Withholding Requirements

 

 

Application for Reduction of Amount Required to be Withheld

 

 

Withholding and Reporting Obligations

 

 

Sample Picture

 

The U.S. imposes 10% or greater withholding tax on sales of U.S. real property by entities with foreign owners – you should speak to your tax advisor about potentially arranging for exemption or for a lesser amount of withholding.

 

Background

 

To ensure collection of a foreign owner’s tax on disposition of U.S. real property, 1984 amendments to the 1980 Foreign Investors in U.S. Real Property Tax Act (FIRPTA) were enacted to impose withholding and reporting liability on the buyer and certain others involved in transactions involving a U.S. real property interest (USRPI).  These requirements were discussed in a previous article as they relate to the 10%-of-gross withholding tax on disposition of a directly-owned USRPI.  This article focuses on the requirements with regard to disposition of an indirectly-owned USRPI (held through a business entity including domestic or foreign corporations, limited liability companies, partnerships, trusts and estates).  Special rules for publicly-traded partnerships and trusts or real estate investment trusts (REIT’s) are not discussed.

Partnership With a Foreign Partner

 

If a domestic partnership disposes of a USRPI, it must withhold a tax of 35% of each foreign partner’s distributive share of the gain realized by the partnership.  However, a domestic partnership is exempt from the FIRPTA requirements if it complies with the general withholding rules for foreign partners.  Under the general withholding rules, a partnership must withhold tax each quarter on each foreign partner’s distributive share of partnership “U.S. effectively connected” taxable income at the applicable percentage (currently 35%).  Withholding applies whether or not the partnership actually distributes profits to its foreign partners.
 

A foreign partnership disposing of a USRPI is subject to the 10%-of-gross withholding regime and any FIRPTA tax thus withheld is applied to reduce the amount of withholding required under the general withholding rules for foreign partners.

 

If a foreign partner transfers his interest in a domestic or foreign partnership with assets primarily invested in USRPI’s, the transferee (buyer) is liable to withhold 10% of the amount realized on the disposition.  Otherwise, although FIRPTA includes provisions imposing 10% withholding on a foreign partner’s disposition of any partnership interest, or any partnership’s distribution of a USRPI to a foreign partner, no withholding is presently required since the IRS has not yet issued implementing regulations.

 

Trust or Estate With a Foreign Owner or Beneficiary

 

If a domestic trust or estate disposes of a USRPI, the trustee, executor or other fiduciary must withhold a tax of 35% of any distribution to a foreign beneficiary attributable to the balance in the “USRPI account” on the day of the distribution.  The “USRPI account” equals the entity’s undistributed net gains and losses realized during the year.  An ordering rule provides that distributions are sourced first from the “USRPI account” then to other amounts.  A special rule applies for a “grantor trust” requiring the trustee or other fiduciary to withhold a tax of 35% of gain realized by the trust from each disposition of a USRPI to the extent such gain is allocable to a portion of the trust treated as owned by a foreign person (whether or not actually distributed).

 

Disposition of a USRPI by a foreign trust or estate is subject to the 10%-of-gross withholding regime.

 

No FIRPTA withholding is required on a foreign owner’s disposition of his trust or estate interest, or on distribution by a trust or estate of a USRPI to a foreign owner, until implementing regulations are issued by the IRS.

 

 

Distribution of USRPI by a Foreign Corporation

 

A foreign corporation that distributes a USRPI must pay withholding tax of 35% of the amount of gain recognized by the corporation on the distribution (including distributions in liquidation or redemption).  Gain is computed as the excess of the fair market value of the USRPI (as of the time of the distribution) over its adjusted basis.  The withholding tax is applied as a credit against the foreign corporation’s U.S. income tax liability.

Distribution of USRPI by Certain Domestic Corporations

 

A domestic corporation with assets primarily invested in USRPI’s that distributes any property to a foreign shareholder in liquidation or redemption generally must withhold a tax equal to 10% of the fair market value of the property distributed (or a lesser rate determined under the elective 1999 final regulations’ mixed regime).  A domestic corporation is considered to have its assets primarily invested in USRPI’s if the market value of its USRPI’s is at least 50% of the market value of all its assets at the time of distribution or at any time during the previous 5 years.

 

Transactions Exempt from Withholding Requirements

 

No withholding applies if the disposing entity is not a foreign person and provides valid certification (a disregarded entity may not so certify - this applies, for example, to a domestic single member LLC).  No withholding applies for a foreign corporation that has elected to be treated as a U.S. corporation for FIRPTA purposes.  No withholding applies upon transfer of shares in a domestic corporation, or interest in a partnership, whose assets are not primarily invested in USRPI’s (a statement to that effect issued by the entity may be relied upon only if it is issued not more than 30 days prior to the transfer).  No withholding applies if the transaction qualifies under a nonrecognition provision (such as the like-kind exchange rules) provided timely notice, including tax ID numbers for each party to the transaction, is filed with the IRS by the 20th day after the transfer.  And finally, if withholding is required under one set of FIRPTA rules, withholding is not also required under the other.

 

Application for Reduction of Amount Required to be Withheld

 

The IRS will consider applications for reduction or elimination of the amount of withholding tax if the withholding otherwise required exceeds the taxpayer’s maximum tax liability, if the transfer is exempt under a nonrecognition provision, or if a payment plan agreement is entered into with the IRS.  Such application must be filed on or before the transfer date and the IRS must accept or reject the application within 90 days.

 

Withholding and Reporting Obligations

 

Unless the transaction is exempt from withholding, the entity, trustee or fiduciary must report the transaction to the I.R.S. on Forms 8288 and 8288-A, and pay the required tax withholding, by the 20th day after the date of transfer.  This deadline is extended to the 20th day after the I.R.S. accepts or denies a legitimate application for reduction of the amount required to be withheld.  In either case, the transferor must subsequently file an annual income tax return reporting all U.S. income, claiming any withholding as a prepayment of tax, and paying any balance due or claiming any allowable refund.

 

Douglas J. Kingston is an Arizona certified public accountant (CPA) specializing in international tax planning and compliance for U.S., Canadian, European, Latin American and Asian business and individual clients and may be reached by:

Telephone: (602) 595-5885E-Mail: doug@iTaxCPA.com • URL: http://www.iTaxCPA.com/