For foreign partners involved in partnerships conducting trade or business within the United States, understanding the tax implications of transferring partnership interests is crucial. Section 864(c)(8) of the U.S. Internal Revenue Code specifically addresses these situations, ensuring that gains or losses effectively connected to a U.S. trade or business are properly accounted for. This article breaks down the key aspects of this regulation, providing clarity on notification requirements and the calculation of gains or losses.
When a foreign partner decides to transfer all or part of their interest in a partnership engaged in a U.S. trade or business, this event triggers tax considerations under Section 864(c)(8). It’s important to note that a partnership distribution that results in the recognition of gain or loss is also considered a transfer under these rules. This broad definition ensures that various forms of interest relinquishment are covered.
To maintain compliance, specific notification procedures must be followed. The responsibility falls on several parties: any foreign person making the transfer, any domestic partnership with a direct foreign partner, and any domestic partnership aware of indirect foreign ownership. These entities are obligated to inform the partnership of the transfer in writing within 30 days of the event.
The notification must contain essential details to properly identify the transaction. This includes:
- The full names and addresses of both the transferor (the party selling or transferring the interest) and the transferee (the party receiving the interest).
- The U.S. Taxpayer Identification Number (TIN) for the transferor and, if available, for the transferee.
- The exact date on which the transfer occurred.
It’s worth noting that some exceptions to these notification rules exist. Transfers of interests in publicly traded partnerships are exempt if the interest is actively traded on established securities markets or readily tradable on secondary markets. Additionally, the notification requirement does not apply to a transferor who is deemed to be transferring an interest solely due to receiving a distribution from the partnership itself. This notification can be combined with other reporting requirements, such as the statement required when a partner sells or exchanges interest related to unrealized receivables or inventory, provided all requirements for both sections are met.
Determining the taxable gain or loss under Section 864(c)(8) involves a specific calculation process. Generally, the foreign transferor must first calculate their outside gain or loss on the partnership interest transfer. This calculation adheres to all relevant provisions of the U.S. tax code and its regulations. It’s critical to understand that a foreign transferor may encounter both capital gain or loss and ordinary gain or loss from the transfer, and Section 864(c)(8) must be applied separately to each.
The next step requires comparing these outside gain or loss amounts with the partnership’s “deemed sale effectively connected gain or loss.” This represents the foreign transferor’s share of gain or loss that would have been effectively connected to a U.S. trade or business if the partnership had sold all its assets at fair market value. The partnership is responsible for calculating this amount and providing it to the transferor on Schedule K-1 (Form 1065).
Ultimately, the foreign transferor will only include the lower of the outside gain or loss and the deemed sale effectively connected gain or loss in their income. This comparison is performed separately for both capital and ordinary gains or losses. For instance, if a foreign transferor has an outside ordinary gain, they will compare it to their aggregate deemed sale effectively connected ordinary gain and only treat the portion that does not exceed the latter as effectively connected gain. This nuanced approach ensures accurate taxation of effectively connected income for foreign partners transferring partnership interests.
