For United States (US) tax purposes, the Internal Revenue Code defines a ‘partnership’ as a syndicate, group, pool, joint venture, or other unincorporated organisation through, or by means of which, any business, financial operation, or venture is carried on, and which is not a corporation or a trust or an estate. In summary (and plain English), a partnership is traditionally when two or more people go into business together, not as a corporation.
In addition, the Internal Revenue Code defines ‘foreign’ for purposes of a partnership, as a partnership that is not created or organised in the US, or under the federal or state laws of the US.
HOW ARE FOREIGN PARTNERSHIPS TAXED IN THE US?
In understanding the US taxation of foreign partnerships, it is important to note the following two basic principles:
- Most partnerships are required to report income, deductions, gains, losses, credits, and other information from the operation of a partnership, however the partnership itself does not pay tax on the income; and
- Instead, the partnership passes any income directly to the partners, and the partners are then required to pay taxes.
WHAT ARE THE INDIVIDUAL PARTNER TAX OBLIGATIONS?
A US person (US citizen or US tax resident) who is a partner in a foreign partnership, is subject to tax on their worldwide income, and for this reason we are focusing on non-resident alien (foreign) partners for the purposes of this blog.
If a foreign partnership generates US effectively connected income that is allocable to a foreign partner, the partnership is required to report and pay a withholding tax to the Internal Revenue Service (IRS), and report this to the individual partner. The partner will then have an obligation to file a US income tax return annually.
In summary, partnerships are classed as ‘pass-through’ entities as they do not pay taxes, rather all items of income or gain, losses, tax deductions, and tax credits are distributed or ‘passed-through’ to the partners who are
HOW DOES A FOREIGN PARTNERSHIP REPORT IN THE US?
The US tax reporting obligations of a foreign partnership are determined based on whether the partnership is subject to the ‘general rule’ or two exceptions to the general rule. We will be focusing on the general rule and not exceptions in this blog.
Under the general rule, foreign partnerships, for US tax purposes, must file Form 1065 (US return of partnership income), if either:
- The foreign partnership has income that is effectively connected with the conduct of a trade or business within the US; or
- The foreign partnership has US source income, derived from sources in the US.
The foreign partnership must file Form 1065 if either of the above conditions are met, even if its primary place of business is outside the US and its partners are foreign persons. Schedule K-1 of Form 1065 is used by the partnership to report income and other tax items to its partners (who will then use this information to file their annual US tax returns).
In summary, any partnership that earns income from the US must file a partnership return on Form 1065, even if all partners are foreign persons.
WHAT ARE THE PITFALLS FOR PARTNERSHIPS AND PARTNERS?
Understanding the requirements that a foreign partnership may have in the US can be complex and advice should be sought to ensure the partnership, and by default the partners, are compliant. Often partnerships are unknowingly uncompliant and are at risk of the penalties the IRS impose, both from a partnership and individual perspective.
Often partnerships file these forms in-house, putting a strain on already stretched tax teams at points of the year and causing resourcing challenges. With some partnerships having hundreds of partners, the burden on in-house teams is evident.
Furthermore, managing the timings of in year reporting and withholding, end of year filings for the partnership, and individual filings for the individual partners throughout the year can create a challenge if unfamiliar with the requirements or process.
For the individual partner, a sudden US tax filing requirement can be daunting. Providing the partners with an explanation of their US tax presence and the process is key, so they understand what they are filing and how this impacts their global tax position.
Many foreign partners are not eligible for a Social Security Number (SSN), which is required to file a US tax return, so should obtain an ITIN (Individual Taxpayer Identification Number) with the first year of tax filing. The process to obtain the ITIN can be challenging, especially for a foreign national residing outside the US, or with no connection to the US.
HOW CAN AAB HELP?
We can cover all aspects of partnership and partner compliance in the US, to ensure your partnership is not at risk of penalties and remains compliant with the IRS and state tax authorities.
Recognising the challenges non-US partners face in ensuring compliance, we have developed an automated solution to manage the obligations of foreign partner reporting in the US. Our technology focused approach takes a fraction of the time spent completing this work with a manual process, cutting down on vendor cost and/or time spent from internal teams who could be focused on more valuable work.
With US specialist teams based in the UK and on the ground in the US, we understand the complexities of filing and paying tax in multiple jurisdictions, and we have the expertise and experience to explain this in a way you will understand. Furthermore, we are strong believers in a people first approach, and will assign a dedicated tax contact, on hand to help with all your needs.
Lastly, AAB are certified acceptance agents, which means we can help with obtaining the ITIN, without the need to travel or mail important documents to the US. We can manage all the required paperwork and work with your partners to understand and sign the required forms at a convenient time for them.
Please contact Jess, Doug, or Mike if you would like to discuss how we can assist further or would like any additional information on foreign partnership reporting in the United States.