Sec. 1446(f) regulations: The rules and unanswered questions

The requirement to withhold on dispositions of interests in partnerships by foreign partners can be burdensome. Find out ways to minimize or avoid having to withhold.
By Shan He, CPA, J.D., LL.M.; and Ben Vesely J.D., LL.M.

On Nov. 30, 2020, the Department of the Treasury and the IRS published final regulations (T.D. 9926) under Sec. 1446(f) relating to the withholding obligations for certain dispositions by foreign partners of interests in partnerships engaged in a U.S. trade or business. Sec. 1446(f) may impose withholding and reporting requirements on transferees of those partnership interests and in certain situations, the partnership whose interests are being transferred. This article addresses certain aspects of the withholding rules of the final Sec. 1446(f) regulations, options to eliminate or reduce Sec. 1446(f) withholding, and some outstanding issues.

Sec. 1446(f) background

Introduced as part of the law known as the Tax Cuts and Jobs Act, P.L. 115-97, Sec. 864(c)(8) characterizes a foreign partner's (transferor's) gain or loss from the sale or exchange of a partnership interest as income effectively connected to a U.S. trade or business (ECI) to the extent that the transferor would have had effectively connected gain or loss if the partnership had sold all of its assets at fair market value (FMV) as of the date of the sale or exchange ("deemed sale").

Sec. 1446(f) serves as an enforcement mechanism for Sec. 864(c)(8) by imposing a 10% withholding tax on the amount realized from the disposition. The withholding obligation falls primarily on the transferee or the buyer. If the transferee fails to withhold, Sec. 1446(f)(4) imposes a secondary withholding obligation on the partnership to withhold tax on distributions to the transferee in an amount equal to the amount the transferee failed to withhold (plus interest on that amount).

How to avoid or minimize Sec. 1446(f) withholding

The withholding regime under Sec. 1446(f) is similar to that of Sec. 1445 (withholding of tax on dispositions of U.S. real property interests). Both withholding regimes are very broad, with the assumption that the transfer is generally subject to withholding unless an exception applies. As the withholding is typically on the amount realized, the withholding amount can be much greater than the actual tax liability imposed on the gain. Additionally, in practice, claiming a refund for overwithheld tax can be difficult in practice for foreign partners due to foreign exchange control and other administrative issues. Accordingly, foreign partners/transferors generally seek avenues to avoid or minimize withholding.

A transferee is not required to withhold under Sec. 1446(f) if it properly relies on a certification or on its books and records as described in Regs. Sec. 1.1446(f)-2(b). Regs. Secs. 1.1446(f)-2(b)(2) through (7) provide the following exceptions to Sec. 1446(f) withholding.

  1. Nonforeign status by transferor — This is a certification the transferor provides that states that it is not a foreign person, along with certain other identifying information and is signed under penalties of perjury (e.g., Form W-9, Request for Taxpayer Identification Number and Certification).
  2. No realized gain by transferor — This is a certification provided by the transferor that the transfer of the partnership interest would not result in any realized gain (including ordinary income arising from the application of Sec. 751 and Regs. Sec. 1.751-1) as of the determination date.
  3. Less than 10% effectively connected gain — This is a certification the partnership provides that, in a deemed sale of the partnership's assets at FMV as of the determination date, either (a) the partnership would have no gain that would have been effectively connected with the conduct of a U.S. trade or business (EC gain) or if the partnership would have a net amount of such gain, the amount of the partnership's net EC gain would be less than 10% of the total net gain; or (b) the transferor would not have a distributive share of net gain from the partnership that would have been EC gain, or if the transferor would have a distributive share of that gain from the partnership, the transferor's distributive share of net EC gain from the partnership would be less than 10% of the transferor's distributive share of the total net gain from the partnership. Alternatively, the partnership could certify that it was not engaged in a U.S. trade or business at any time during the partnership's tax year through the date of transfer.
  4. Less than 10% ECI — This is a certification the transferor provides that during the lookback period (typically, the preceding three tax years as defined in Regs. Sec. 1.1446(f)-2(b)(5)(ii)), the transferor's distributive share of gross effectively connected income from the partnership was less than $1 million and less than 10% of the transferor's total distributive share of gross income from the partnership, for each of the tax years in the lookback period. For this purpose, useful documentary evidence is Schedule K-1, Partner's Share of Income, Deduction, Credits, etc., and Form 8805, Foreign Partner's Information Statement of Section 1446 Withholding Tax.
  5. Nonrecognition transfer — This is a certification the transferor provides that by operation of a nonrecognition provision of the Internal Revenue Code, the transferor is not required to recognize any gain or loss from the transfer.
  6. Income tax treaties — This is a certification the transferor provides that it is not subject to tax on any gain from the transfer under an income tax treaty in effect between the United States and a foreign country if the requirements of Regs. Sec. 1.1446(f)-2(b)(7) are met.

In addition, a transferor could also minimize the withholding amount by providing a certification of maximum tax liability under Regs. Sec. 1.1446(f)-2(c)(4). Regs. Sec. 1.1446(f)-2(c)(4) provides a procedure to determine the amount to withhold under Sec. 1446(f)(1) that is intended to estimate the amount of tax that the transferor is required to pay on gain under Sec. 864(c)(8). Specifically, the procedure allows a transferee to withhold based on a certification received from the transferor containing certain information relating to the transferor and the transfer, including the transferor's maximum tax liability (as determined under Regs. Sec. 1.1446(f)-2(c)(4)(ii)) on the transfer.

Regs. Sec. 1.1446(f)-5(b) also provides that any person required to withhold under Sec. 1446(f) is not liable for failure to withhold, or any interest, penalties, or additions to tax, if it establishes to the satisfaction of the Commissioner that the transferor had no gain under Sec. 864(c)(8) subject to tax on the transfer.

Outstanding issues

1. Installment sales

Typically, the amount withheld under Sec. 1446(f) is 10% of the amount realized on the disposition. Regs. Sec. 1.1446(f)-2(c)(2) provides, in part, that the amount realized on the transfer of the partnership interest is determined under Sec. 1001 (including Regs. Secs. 1.1001-1 through 1.1001-5) and Sec. 752 (including Regs. Secs. 1.752-1 through 1.752-7). Thus, the amount realized includes the amount of cash paid (or to be paid), the FMV of other property transferred (or to be transferred), the amount of any liabilities assumed by the transferee or to which the partnership interest is subject, and the reduction in the transferor's share of partnership liabilities.

The Sec. 1446(f) final regulations do not specifically address withholding on installment sale payments. In the context of Foreign Investment in Real Property Tax Act (FIRPTA), P.L. 96-499, withholding under Sec. 1445, Regs. Sec. 1.1445-2(d)(4) specifically provides that the transferee is generally required to satisfy its entire withholding obligation within the time specified in Regs. Sec. 1.1445-1(c) (i.e., within 20 days after the date of the transfer) regardless of the amount the transferee actually paid. After the withholding amount for the transfer is paid, no withholding is required upon further installment payments on an obligation arising out of the transfer.

Rev. Proc. 2000-35, Section 7.02, however, provides that the IRS will entertain withholding certificate requests to permit the transferee to withhold Sec. 1445 tax as installment payments are made. Specific guidance by Treasury of the Sec. 1446(f) withholding rules on an installment sale payment would be welcome.   

2. Partnership's secondary withholding obligation and exceptions

Under Regs. Sec. 1.1446(f)-2(d)(2), within 10 days after the transfer, the transferee must certify to the partnership the extent to which it has satisfied its obligation to withhold. The certification must either include a copy of the Form 8288-A, Statement of Withholding on Dispositions by Foreign Persons of U.S. Real Property, or state the amount realized and the amount withheld on the transfer. The certification must also include any certifications that the transferee relied on to apply an exception. If it does not receive the certification, the partnership generally must withhold on future distributions to the transferee. See Sec. 1446(f)(4) and Regs. Sec. 1.1446(f)-3(a).

Regs. Sec. 1.1446(f)-3(a)(3) provides that a partnership is not required to withhold on distributions that are made after the date on which the transferee disposes of the transferred interest, unless the partnership has actual knowledge that any person that acquires the transferee's interest in the partnership is a related person, i.e., a person that bears a relationship described in Sec. 267(b) or 707(b)(1) with respect to the transferee or the transferor from which the transferee acquired the interest. 

Regs. Sec. 1.1446(f)-3(b) exempts a partnership from withholding under Regs. Sec. 1.1446(f)-3(a) if (1) it relies on certification described in Regs. Sec. 1.1446(f)-2(d)(2) received from the transferee (within the time prescribed in Regs. Sec. 1.1446(f)-2(d)(2)) that states that an exception to withholding described in Regs. Sec. 1.1446(f)-2(b) applies or that the transferee withheld the full amount required to be withheld; (2) the partnership is a publicly traded partnership; or (3) the partnership is a transferee because it makes a distribution.

Regs. Sec. 1.1446(f)-3(c)(1)(ii) provides that a partnership is treated as satisfying its withholding obligation under Regs. Sec. 1.1446(f)-3(a)(1) and may stop withholding on distributions with respect to a transferred interest on the earlier of (A) the date on which the partnership completes withholding and paying the amount required to be withheld under Regs. Sec. 1.1446(f)-3(c)(2) or (B) the date on which the partnership receives and may rely on a certification from the transferee described in Regs. Sec. 1.1446(f)-2(d)(2) (without regard to whether the certification is received by the time prescribed in Regs. Sec. 1.1446(f)-2(d)(2)) that claims an exception to withholding under Regs. Sec. 1.1446(f)-2(b).

In addition, Regs. Sec. 1.1446(f)-3(a)(1) provides a partnership that already possesses a certification of non-foreign status (including a Form W-9) for the transferor that meets the requirements provided in Regs. Sec. 1.1446(f)-2(b)(2) may instead rely on this certification to determine that it has no withholding obligation under Regs. Sec. 1.1446(f)-3(a)(1) unless it knows, or has reason to know, that the certification is incorrect or unreliable. An expansion of this rule may be reasonable where the partnership already has the relevant knowledge and documentary evidence.

For example, if the partnership had access to documentary evidence such as Schedule K-1 and Form 8805 that supports the application of the "less than 10% ECI" exception in Regs. Sec. 1.1446(f)-2(b)(5), it seems reasonable to allow the partnership to rely on the documentary evidence and be relieved from withholding under Regs. Sec. 1.1446(f)-3(a).

Going forward

To avoid or minimize the withholding amount, it is recommended that the transferor plan before the transfer takes place, consult a tax adviser to analyze and determine whether any exceptions apply, and collect necessary information to provide the proper certification or statement to the transferee, where applicable. Hopefully, Treasury can provide specific guidance of the Sec. 1446(f) withholding rules on an installment sale payment and expand and clarify the exceptions in Regs. Sec. 1446(f)-3(b).

— Shan He, CPA, J.D., LL.M., is a senior associate in International Tax at BDO in Irvine, Calif.; and Ben Vesely, J.D., LL.M., is a principal in International Tax at BDO in San Jose, Calif. For comments on this article or suggestions of other topics, contact Sally Schreiber, senior editor, at

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