New Tax Relief Act of 2010 Extends 15% Withholding on United States Real Property Gains Pass Through to Foreign Persons by U.S. Partnerships, Trusts or Estates
A U.S. partnership, trustee of a U.S. trust, or executor of a U.S. estate must deduct and withhold income tax on distributions attributable to the disposition of a U.S. real property interest (“USRPI”) to the extent it is includible in the income of a foreign partner, foreign beneficiary, or, in the case of a trust, a foreign person under the grantor trust rules per §671 et seq. For amounts paid after May 28, 2003, the Service was authorized to issue regulations to reduce the amount of income tax required to be withheld on a foreign person's gain from the disposition of an interest in U.S. real property from 35% to 15%. Since the Service had not issued regulations providing for the 15% rate, domestic partnerships, estates, and trusts had to withhold tax at 35%.
Under section 303 of the 2003 Jobs and Growth Act (JGTRRA, Sec. 303, PL 108-27, 5/28/2003 ), as amended by section 102 of the 2005 Tax Increase Prevention Act (TIPRA, Sec. 102, PL 109-222, 5/17/2006 ), the Service’s authority to provide for a reduced 15% withholding rate by regulation was to expire for payments made in tax years beginning after Dec. 31, 2010 (in which case the rate reduced rate would have reverted to the earlier 20%). Under the Act, the IRS has been granted authority to provide a 15% withholding rate on a distribution from a partnership, trust or estate attributable to the disposition of a USRPI for two additional years, i.e., tax years beginning before Jan. 1, 2013.
Background
Section 1445(e) sets forth special withholding rules apply for distributions and other transactions involving domestic or foreign corporations, partnerships, trusts and estates. Compare §1445(a). Withholding is avoided where, for example, a nonrecognition provision applies to a transfer and notice of the transfer is given to the Service, or if the holder of an interest in the entity isn't a foreign person. Similarly, withholding may not be required if there isn't a United States real property interest (“USRPI”) involved. Where withholding is required under §§1441 or 1442 on a transfer, withholding is not required under §1445. See Treas. Reg. §1.1445-5 .
The withholding requirement for U.S. partnerships, trusts and estates on gains realized from dispositions of a USRPI to the extent such gain is includable in the income of a foreign interest holder, does not apply where gain or loss qualifies for nonrecognition treatment and a proper notice is provided. The entity or fiduciary of a trust or estate may, but is not required to, obtain a withholding certificate from the Service. Where the disposition results in partial recognition, the withholding requirement does apply to such extent unless a withholding certificate is obtained. Treas. Reg §1.1445-5(b)(2)(i) .
Taxable Dispositions of a USRPI. A domestic partnership, trust or estate is required to withhold on the disposition of a USRPI if any foreign persons are partners, beneficiaries, or owners of the entity. The rate of withholding is 35% of each foreign partner's, beneficiary's or owner's proportionate share of the amount realized by the entity. PL 103-66, 8/10/93 . As mentioned, the Tax Relief Act gives the Service an additional two years to issue regulations to reduce the rate of tax to 15%. See §1445(e)(1). No withholding is required on distributions of USRPIs by a partnership, trust, or estate at this time. They will be subject to withholding under §1445(e)(4) and Treas. Reg §1.1445-5(f) on the effective date of a later issuance of final regulations under §897.
Dispositions of Interest in Partnerships, Trusts or Estates. The law provides for 10% withholding by transferees on disposition by foreign persons of their interest in partnerships, trusts and estates. See §. 1445(e)(5) . Under regulations, withholding applies to dispositions of interests in partnerships in which 50% or more of the value of the gross assets consist of USRPIs and 90% or more of the value of the gross assets consist of USRPIs plus any cash or cash equivalents. A withholding certificate under Treas. Reg §1.1445-3 may be requested from the IRS if reduced withholding is appropriate. Withholding is not required if the transferees receive a statement from the partnership that 50% or more of the value of the gross assets doesn't consist of USRPIs or that 90% or more of the value of the gross assets doesn't consist of USRPIs plus cash or cash equivalents. Treas. Reg §1.1445-11T .
Publicly Traded Partnerships and Trusts; REITs. For distributions of USRPIs, Treas. Reg §1.1445-8(b)(1) , provides that a partnership or trust with interests regularly traded on an established securities exchange (regardless of the number of partners or beneficiaries), or a REIT (regardless of its form), has the primary obligation for withholding. There are certain exceptions. See Treas. Regs. §§1.1445-8(d), -8(f), -8(b)(3).
Withholding from Amounts Distributed by Qualified Investment Entities. For distributions described under §897(h)(1) from a REIT or a RIC to a non-resident alien individual or foreign corporation, the investment entity must deduct and withhold a tax of 35% of the amount so treated, unless the IRS provides for a 15% rate (20% for tax years beginning after Dec. 31, 2010) in regulations. §1445(e)(6).
Distributions by Foreign Corporations. Distributions by foreign corporations to any interest-holder of a USRPI are subject to withholding §1445(e)(2) . Withholding of 35% of the gain is required per §897.. Withholding isn't required if the property distributed isn't a USRPI. If the corporation relied on a statement of non- USRPI that it later learns is false, the duty to withhold applies in full. An extension of the deadline is permitted to allow for the belated awareness. Treas. Reg §1.1445-5(d) .
Distributions by USRPHCs. Distributions by U.S. corporations that are (or were) USRPHCs with respect to certain property to foreign persons are subject to withholding under § 1445(e)(3) . Withholding of 10% on distributions in redemption of stock under §302 or in complete liquidations to a foreign person if the person's interest in the corporation is a USRPI. See §1445(e)(3) ; Treas. Reg §1.1445-5(e)(1) . Similar withholding applies to non-dividend distributions per §301 where made out of earnings and profits. See §1445(e)(3). See Treas. Reg. §1.1445-5(e)(2).
Distributions by U.S. of Foreign Partnerships, Estates or Trusts. . Where a U.S. or foreign partnership, the trustee of a U.S. or foreign trust, or the executor of a U.S. or foreign estate distributes a USRPI (in a distribution that is taxable under the FIRPTA rules of §897 to a partner, trust or estate beneficiary who is a foreign person, the partnership, trustee, or executor is required to deduct and withhold under §1445(a) 10% of the fair market value of the distributed USRPI. §1445(e)(4) . However, withholding is required under §1445(e)(4) only for distributions made on or after the effective date of a final regulation for §897(g) and §897(e)(2)(B)(ii). See also Treas. Regs. §§ 1.1445-5(b)(8)(iv) ; 1.1445-11T(c) . No regulations have been issued for taxable distributions from partnerships, trusts or estates under §897.
Withholding Certificates for Partnerships, Trusts, Estates and Corporations. The withholding obligation of partnerships, trusts, estates and corporations on dispositions of USRPIs may be reduced or eliminated under a withholding certificate issued by the Service. Treas. Reg §1.1445-6(a)(1) . A withholding certificate may be issued to permit the adjusted amount to reflect the relevant taxpayer's maximum tax liability. See Treas.Regs. §1.1445-3(c)(2); §1.1445-6(c) . The IRS will issue a withholding certificate to reduce or eliminate withholding if an affected taxpayer is exempt from U.S. tax because it is an integral part or controlled entity of a foreign government, or because it is entitled to treaty benefits. Treas. Reg §1.1445-6(d) . See also Treas. Reg. §1.1445-6(e)(1). Other special rules apply with respect to the filing of a request of a withholding certificate.
Effect on Interest Holder of Withholding by Partnership, Estate, or Trust. Withholding per §1445(e)(1) does not eliminate or excuse a foreign person from filing a U.S. income tax return. The tax withheld will be credited against income tax due, but only if a stamped copy of Form 8288-A provided to the entity or fiduciary is attached to the return. If the form has never been provided by the IRS to the interest holder, the interest holder may substitute substantial evidence of the amount withheld. In that case, the interest holder must attach a statement. Treas. Reg §1.1445-5(b)(7) . The statement must set forth the information listed in the regulations. Treas. Reg §1.1445-1(d)(2) . Additional rules are provided in the regulations.
Section 897(i) Elections by a Foreign Corporation. In such instance the foreign corporation is treated as a U.S. corporation under §1445. See Treas. Reg. §1.1445-7. Withholding is required for transfers of interests for §897(i) electing corporations, unless the transferee ascertains that the interests aren't USRPIs. Withholding may be required for nondividend distributions to interest holders. Treas. Reg §1.1445-7 . Since a foreign corporation that has made an election under §897(i) is treated as a U.S. corporation, it will not be subject to §1445(e)(2) that it withhold at the corporate capital gain rate on the gain it recognized from the distribution of a USRPI. It is still subject, however, to §1445(e)(3), governing distributions by certain U.S. corporations to foreign shareholders .Treas. Reg §1.1445-7(c) .
