We know that a partnership is a pass through entity which means it doesn’t pay taxes itself. Incomes and expenses pass through to the partner’s and the partners themselves will pay taxes based on their share of the partnership’s income. There is no tax withholding. This is true unless the partnership has one or more foreign partners. A partner is a foreign partner if the partner is a nonresident alien individual, foreign partnership, foreign corporation (including a foreign government), foreign estate or trust, foreign tax-exempt organization, or other foreign person.
A U.S. non-publicly traded partnership has a legal responsibility to withhold and pay tax if any portion of its effectively connected taxable income (ECTI) is allocable to a foreign partner. Generally, the withholding tax rate is 30 percent, however, it may be reduced by a treaty tax rate. Withholding is also required on a foreign partner's distributive share of income that is not distributed. If tax was withheld prior to a distribution, taxes do not have to be withheld again when the amount is distributed.
The partnership must pay the withheld amount in installments based on the estimated tax requirements together with a Form 8813. The partnership must also report the partnership's total withholding liability for the year on Form 8804 and notify each foreign partner of his/her share on Form 8805.
Foreign partners need to file their US return on Form 1040NR, Form 1065, Form 1120F, or any other appropriate return, and any tax due must be paid, by the filing deadline (including extensions) generally applicable to that person. A foreign partner may claim a withholding credit for its share of any tax paid by the partnership against the amount of income tax computed on the foreign partner's return.
For example, U.S. partnership Z has a foreign partner P who owns a 20 percent of interest in the partnership. In 2009, Z has business net income $100,000. Z must withhold 30 percent or $6,000 tax for P’s $20,000. The $6,000 will be included in P's distribution calculation, so the other partners aren't penalized for the withholding.
However, for publicly traded partnerships (PTPs), the issue of withholding for foreign partners is handled differently. PTPs that have effectively connected income, gain, or loss must withhold from distributions to foreign partners, rather than on effectively connected taxable income.
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