New withholding regime on transfers of partnership interests

By Pietro Stuardi, CPA, MST, and Ryan Faulstich, CPA, MST, New York City

Editor: Mark Heroux, J.D.

The IRS issued proposed regulations (REG-105476-18) on May 7, 2019, that address the new withholding provisions applicable to transfers of partnership interests under Sec. 1446(f). The new regime has a profound impact on partnerships and their partners, whether domestic or foreign. Overturning a taxpayer-favorable Tax Court decision (Grecian Magnesite Mining, Industrial & Shipping Co., SA, 149 T.C. 63 (2017), aff'd, 926 F.3d 819 (D.C. Cir. 2019)), Congress enacted Sec. 864(c)(8) as part of the law known as the Tax Cuts and Jobs Act, P.L. 115-97.

Under the new provision, gain from the sale of an interest in a partnership that is engaged in a U.S. trade or business is treated as effectively connected income, and therefore generally subject to federal tax, in the hands of a foreign person that is not otherwise engaged in a U.S. trade or business. Sec. 1446(f) ensures the collection of the substantive tax of Sec. 864(c)(8) by imposing withholding equal to 10% of the amount realized on the sale, exchange, or other disposition of certain interests in partnerships.

Taxpayers may currently rely on the interim guidance of Notice 2018-29 to comply with the withholding mandate of Sec. 1446(f). If finalized, the proposed regulations would partially modify the current guidance, fine-tuning some of the procedural rules. This discussion focuses on the withholding regime under the proposed regulations applicable to non-publicly traded partnerships and highlights a number of compliance and practical implications. Unless otherwise noted, reference to partnerships does not include publicly traded partnerships.

It is worth a reminder that the withholding of Sec. 1446(f) does not relieve a foreign transferor from filing a federal income tax return for the year of the sale to report the final tax liability, net of the credit for any withholding.

Withholding framework

The framework of the withholding regime starts out broadly by imposing a 10% withholding obligation on any transferee on any transfer of a partnership interest in any partnership. The proposed regulations then provide enumerated exceptions that exempt a transferee from the withholding requirement. However, no exception applies unless the transferee obtains the prescribed certification from either the transferor or the partnership.

To be relied upon, a certification must meet certain formal requirements defined in the proposed regulations, and the transferee must not have actual knowledge that the certification is incorrect or unreliable. It is worth noting that a certification may not be relied upon if it is obtained earlier than 30 days before the transfer or any time after the transfer. These requirements alone make it important to plan ahead for any transfer of a partnership interest.

The definition of a withholdable transfer under the proposed regulations includes a partnership distribution in excess of basis. In that instance, the partnership is treated as the transferee responsible for withholding, unless one of the exceptions applies.

The proposed regulations provide for six potential exceptions:

  • The transferor certifies that it is not a foreign person;
  • The transferor certifies that no gain would be recognized in the transaction, including ordinary income from Sec. 751;
  • The partnership certifies that if all of the partnership's assets were sold at fair market value (FMV), the amount of net gain effectively connected with a U.S. trade or business would be less than 10% of the net total gain or no gain would be effectively connected with a U.S. trade or business;
  • The transferor certifies that it was a partner in the partnership for at least the three preceding tax years and, in each of those years, the transferor's share of effectively connected taxable income was less than $1 million and less than 10% of the transferor's distributive share of partnership net income, and, generally, the transferor's distributive share of income or gain (and related deductions and losses) effectively connected with a U.S. trade or business has been reported on a federal income tax return filed on or before the due date (including extensions) and all amounts due with respect to the reported amounts have been timely paid (a number of stringent requirements need to be met for the transferor to be able to make these representations);
  • The transferor certifies that no gain was recognized because the transfer was a nonrecognition transaction; or
  • The transferor certifies that the gain is not subject to tax under a U.S. tax treaty.
Amount of withholding

When no exception applies, 10% of the amount realized must be withheld. The amount realized includes cash, the FMV of the transferred property, the amount of liabilities assumed by the transferee, and the reduction in the transferor's share of partnership liabilities.

Determining the transferor's share of liabilities at the time of the transfer may prove difficult in many circumstances. This would be the case, for example, for a selling partner in a large investment fund or a fund of funds with a complex tiered structure in which the liabilities allocated by each underlying partnership roll up to the fund partner.

Instead of determining the amount of the transferor's liabilities, a transferee (other than a partnership that is a transferee because it makes a distribution) may rely on a certification of the liabilities by the transferor or the partnership. With respect to a certification from a transferor, the transferee may rely on a certification from a transferor, other than a controlling partner, that provides the amount of the transferor's share of partnership liabilities reported on the most recent Schedule K-1 (Form 1065), Partner's Share of Income, Deductions, Credits, etc., issued by the partnership. For a certification from a partnership, the transferee may rely on a certification that provides the amount of the transferor's share of partnership liabilities on the determination date.

In either case, if the transferor's actual share of liabilities at the time of the transfer differs from the amount reported on that Schedule K-1, the certification will not be treated as incorrect or unreliable if the transferor or partnership makes an additional certification: The transferor or partnership must also certify that it does not have actual knowledge of any events occurring after the relevant time (receiving the Schedule K-1, for a transferor, or the determination date, for a partnership) that would cause the amount of the transferor's share of partnership liabilities at the time of the transfer to differ by more than 25% from the amount shown on the relevant document (the Schedule K-1, for a transferor, or the determination date, for a partnership). Notably, when the transferee is not provided with either certification and does not otherwise have actual knowledge of the transferor's share of liabilities, the entire amount realized must be withheld — an extremely harsh outcome that may result from an administrative oversight.

Even absent procedural mishaps, the amount of withholding can place a significant financial hardship on the transferor, since the general withholding computation ignores the seller's cost basis, including any basis resulting from the pro rata share of the partnership liabilities. The proposed regulations offer some relief in the form of a certification of maximum tax liability that a foreign corporation, a nonresident alien individual, or a foreign partnership may provide to the transferee in advance of the transaction.

If all the procedural requirements are satisfied, which include the transferor's obtaining prescribed information from the partnership, the transferee may rely on the certification and withhold based on the transferor's maximum tax liability, which is the transferor's applicable percentage multiplied by the transferor's effectively connected gain on the transfer. The applicable percentage is the highest rate of tax for each particular type of income or gain allocable to a foreign person. This should be a critical planning point for non-U.S. taxpayers approaching a sale of a partnership interest.

Partnership 'backstop' withholding

The proposed regulations place the primary withholding responsibilities on the acquirer of a partnership interest. In addition, the partnership itself is given a policing role to ensure that no tax revenue leaves the shores of the United States. If a transferee fails to withhold on a transfer, the partnership is responsible to deduct and withhold from distributions to the transferee an amount equal to the originally required 10% withholding of the realized amount plus applicable interest.

Again, meeting procedural requirements is critical. Unless a partnership receives, within 10 days from the transfer, a certification from the transferor that withholding is not required under an applicable exception or that the proper amount was withheld, and it does not know or have reason to know that the certification is incorrect or unreliable, it must withhold on subsequent distributions to the transferee. A partnership that does not receive, or cannot rely on, a timely certification must begin withholding on distributions to the transferee on the later of 30 days after the transfer date or 15 days after the partnership receives actual knowledge of the transfer.

Deposit and reporting requirements

A transferee required to withhold on a transfer has a relatively short time frame to report and remit the tax collected. Specifically, the transferee must report and remit tax withheld no later than the 20th day after the transfer date. To report and pay the amount withheld, the transferee uses Forms 8288, U.S. Withholding Tax Return for Dispositions by Foreign Persons of U.S. Real Property Interests,and8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property Interests. The IRS will mail a copy of Form 8288-A, stamped to show receipt, to the transferor.

Planning and procedures for partnerships and their partners

The broad withholding regime imposes new administrative requirements for all taxpayers involved in a transfer of a partnership interest. Due to the wide net cast by the new rules, any time a transfer of a partnership interest takes place, even a transfer between two U.S. persons, proper certification is required to document an exemption from withholding. Aside from the certification of nonforeign status, the exemptions are cumbersome and require substantial administrative effort.

In the event of a withholding requirement, the volume of information required to calculate the proper amount of withholding is significant, especially when a foreign seller seeks to establish a lower withholding amount under the maximum tax liability procedure, and will require coordination among the transferee, the transferor, and the partnership.

The costs of failing to comply with these stringent requirements can be steep, and the time frame to complete the procedures is short. Considering most partnership deals are time-sensitive, proper planning and preparation on the buy and sell sides are critical to avoid unpleasant surprises.

Partnerships, on the other hand, should proactively discuss their partners' transfer requirements and consider incorporating relevant language into their partnership agreements. In addition, partnerships with foreign partners should consider adopting appropriate procedures to ensure the partnerships are equipped to provide accurate and timely information to all parties involved in a transfer.


Mark Heroux, J.D., is a principal with the Specialty Tax Services Group at Baker Tilly Virchow Krause LLP.

For additional information about these items, contact Mr. Heroux at 312-729-8005 or

Unless otherwise noted, contributors are members of or associated with Baker Tilly Virchow Krause LLP.

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