If a foreign partner has effectively connected income and is part of a partner’s distributive share of any items of income, gain, loss, deduction, or credit then you may need to file a forms 8804, 8804-C, and 8805 with your US partnership tax return (Form 1065).
A foreign partner is one who is not a “US person.” In other words, a nonresident alien individual or a foreign corporation, partnership, trust or estate.
Effectively connected taxable income essentially provides that income of a partnership is associated with a trade or business in the United States. This term may seem simple in appearance, but has very nuanced meanings depending on your particular situation.
Disposition of a Partnership Interest Where Effectively Connected Income Exists
Under IRC section 1446(f)(1), a transferee of an interest in a partnership must withhold 10% of the amount realized on the disposition of an interest in a partnership if any portion of the gain (if any) on the disposition would be treated under IRC section 864(c)(8) as effectively connected with the conduct of a trade or business within the United States.
Withholding Rate for Non Residents
Currently, the withholding tax rate for effectively connected income allocable to non-corporate foreign partners is 37%, and 21% for corporate foreign partners. In other words for non-corporate partners, the highest rate will apply.
Good News comes with a Requirement- How to Claim Foreign Tax Credit
Foreign partners may be allowed a tax credit for their share of the tax withheld and will need to file a US tax return. The type of tax return depends on the type of foreign partner they are- for example a 1040NR or 1120F.
What to Watch out For
Foreign partnerships must pay the withholding tax for a foreign partner even if the partnership does not have a US tax identification number (or TIN) for that partner.
How to pay the tax
Form 8813 is a voucher submitted along with a payment.