On April 2, 2018, the Internal Revenue Service ("IRS") released Notice 2018-291 (the "Notice"), announcing the intention of the IRS and the Department of the Treasury to issue regulations regarding the withholding requirements under Section 1446(f),2 which was promulgated pursuant to recently enacted U.S. tax legislation, commonly referred to as the "Tax Cuts and Jobs Act".3 The Notice also provided interim guidance that taxpayers may rely on until further guidance is issued.
The Notice does not affect the suspension of withholding pursuant to Section 1446(f) for publicly traded partnerships under Notice 2018-08, issued in December of 2017, nor does the guidance related to Section 1446(f) affect a transferor's tax liability under Section 864(c)(8).
For dispositions of partnership interests occurring after December 31, 2017, Section 1446(f) generally requires the transferee to withhold and remit 10 percent of the "amount realized" by the transferor, if any portion of the gain (if any) realized by the transferor would be treated as effectively connected with the conduct of a trade or business in the United States under Section 864(c)(8). The "amount realized" generally includes proceeds (whether cash or other property) as well as any liabilities deemed assumed by the transferee for tax purposes. Though Section 1446(f) generally requires a transferee to effect the withholding, Section 1446(f)(4) imposes a secondary obligation on the transferred partnership: in the event the transferee fails to withhold and remit the appropriate amount, the partnership is required to withhold and remit the amount of the shortfall (together with interest) from its subsequent distributions to the transferee.
Reporting and Paying Over Withheld Amounts
In the Notice, the IRS has indicated that the procedural regime that exists under the Foreign Investment in Real Property Tax Act of 1980 ("FIRPTA") and Section 1445 generally will also apply to Section 1446(f). Generally, this will mean reporting and paying over any withheld amounts within 20 days of the relevant transfer. The IRS has asserted that withholding agents will not be subject to interest and penalties on account of late payment if any withholding that, per the Notice, is due prior to May 31, 2018, is paid in full on or prior to May 31, 2018.
The IRS is not currently issuing new forms for Section 1446, and taxpayers are generally instructed to continue to use the forms required under Section 1445 (with "Section 1446(f)(1) withholding" noted on the relevant form).
Where withholding is required under both Section 1445 and Section 1446(f), the transferee need only withhold pursuant to Section 1445 (unless the transferor has obtained a withholding certificate pursuant to Treasury Regulations Section 1.1445-11T(d)(1), in which case the transferee must withhold the greater of the amount required to be withheld pursuant to Section 1445 and the amount required to be withheld pursuant to Section 1446(f)).
Suspension of Secondary Partnership Withholding Obligation
Until further guidance is provided, the IRS has suspended the secondary withholding obligation imposed on partnerships in the event a transferee fails to appropriately withhold in accordance with Section 1446(f).
Exceptions to Withholding Requirements
Pursuant to the statutory exception provided in Section 1446(f)(2), the IRS has provided that withholding will not be required where a transferor certifies its non-foreign status in an affidavit, signed under penalties of perjury, containing the transferor's U.S. taxpayer identification number (if applicable). Generally, a correct and complete Form W-9 will satisfy these requirements. Until the IRS issues further guidance, such certifications should not be remitted to the IRS. As with FIRPTA, where a transferee has actual knowledge, or receives notice from its agent or the transferor's agent, that a certification is false, the certification may not be relied upon.
In addition to the statutory exception, the Notice provides that withholding is generally not required where (i) a transferor certifies that no gain will be realized in the disposition, (ii) a transferor certifies, no more than 30 days prior to the date of transfer, that, for the "immediately prior taxable year"4 and the two taxable years that precede it, it has been a partner in the partnership for the entirety of each such taxable year and its share of effectively connected taxable income (as determined under Treasury Regulations Section 1.1446-2) for each such taxable year was less than 25% of its total distributive share for such year,5 or (iii) the transferred partnership certifies, no more than 30 days prior to the date of transfer, that the amount of gain that would be treated as effectively connected with the conduct of a trade or business within the United States if the partnership were to sell all of its assets as of the date of the certification would be less than 25% of the total gain.6 As with the certification of non-foreign status, these certificates must be signed under penalties of perjury, and the certifications provided by the transferor must also contain the transferor's U.S. taxpayer identification number (if applicable).
Lastly, the IRS has provided that no withholding is required in nonrecognition transactions where the transferor provides the transferee a notice that satisfies the requirements of Treasury Regulations Section 1.1445-2(d)(2) (which also requires that the relevant statement be made under penalties of perjury), treating references therein to "1445(a)" and "U.S. real property interest" as references to "1446(f)" and "partnership interest", respectively (though until further guidance is issued, transferees should not remit such notices to the IRS). The IRS specifically noted that future regulations regarding the treatment of nonrecognition transactions under Section 864(c)(8) may impact this.
Determining Partnership Liabilities included in Amount Realized
For purposes of determining the amount of liabilities included in a transferor's amount realized, the IRS has generally provided for certificates that may be issued (under penalties of perjury) in certain circumstances by certain transferors or transferred partnerships. These certificates will generally allow a transferee to rely on the amount of partnership liabilities reported as apportioned to the transferor on the most-recent Schedule K-1 (Form 1065) of the transferred partnership, and will need to state that the certifier has no actual knowledge of events that would alter such amount by 25 percent or more.
No Withholding in Excess of Proceeds Paid
The Notice generally provides that in no event shall a transferee be required to withhold an amount in excess of the amount realized less the liabilities deemed assumed by the transferee in the transfer. This means there is no "dry withholding" requirement – as a transferee's obligation to withhold is capped by the cash or other property paid in the transaction.
Application to Distributions
In clarifying that Section 1446(f) also applied to certain partnership distributions, the IRS has provided that a partnership may rely on either its own books and records or a certification from the distributee partner when determining whether the distribution exceeds the partner's basis in its partnership interest, and thus whether the distribution will be, at least in part, treated as a transfer subject to Section 1446(f).
Application to Tiered Partnerships
A look-through rule will be used to determine the amount of effectively connected taxable income realized pursuant to Section 864(c)(8) by a transferor that disposes of an 'upper-tier' partnership that also owns 'lower-tier' partnerships. The IRS has indicated that future regulations will require lower-tier partnerships to furnish information to upper-tier partnerships in order to effectuate this look-through rule and related withholding obligations.
Request for Comments
The IRS has also requested comments on the rules to be issued under Section 1446(f). Of specific interest, the IRS has asked for comments regarding (i) rules for determining the amount realized, including when the required withholding exceeds the proceeds of a sale and (ii) procedures that reduce the amount to be withheld, including in connection with "identifiable historically compliant taxpayers".
Former summer associate Christine Sherman provided invaluable assistance in preparation of this updateChristine Sherman
1 "Guidance Regarding the Implementation of New Section 1446(f) for Partnership Interests That Are Not Publicly Traded."
2 Unless otherwise noted, all references to 'Sections' herein are references to sections of the Internal Revenue Code of 1986, as amended.
3 Public Law No: 115-97, enacted December 22, 2017. The legislation does not have a short title; the official title is "H.R.1 – An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018."
4 A transferor's "immediately prior taxable year" is the most recent taxable year of the transferor that includes the partnership taxable year that ends with or within the transferor's taxable year and for which both a Form 8805, Foreign Partner's Information Statement of Section 1446 Withholding Tax, and a Schedule K-1 (Form 1065) were due (including extensions) or filed (if earlier) by the time of the transfer. This appears to mean that, for a transferor that files on a calendar-year basis and transfers as of, say, January 1, 2018, the "immediately prior taxable year" would actually be 2016 - but further guidance from the IRS will be necessary to confirm that.
5 Transferees may not rely on such certificates prior to the transferor's receipt of the relevant Schedule K-1s (Forms 1065) and Forms 8805.
6 For the 25% tests described in (ii) and (iii), the IRS is considering lowering the withholding threshold. This would have the impact of subjecting more transfers to withholding.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.