U.S. Tax on a Foreign Person’s Gain from the Sale of a U.S. Partnership Interest

Blog
February 2, 2018

There is a provision in the new U.S. tax legislation that applies to a foreign person’s sale of a U.S. partnership interest. According to the new rule, a foreign partner must treat the gain on the sale of a U.S. partnership interest as effectively connected income from a U.S. trade or business. This means that the foreign partner is required to pay U.S. tax on ordinary income instead of capital gain from the sale of the U.S. partnership interest. This rule is consistent with the IRS’ position in Revenue Ruling 91-32. In 2017, the U.S. Tax Court decided in the Grecian Magnesite case not to follow the IRS’ position in Rev. Rul. 91-32. The new legislation reinstates the IRS’ position in  Rev. Rul. 91-32 and renders the U.S. Tax Court decision obsolete.

A partner in a U.S. partnership generally recognizes capital gain on the sale of a partnership interest. An exception to this rule recharacterizes the gain as ordinary income. The amount recharacterized is the partner’s share of income from a hypothetical deemed sale of the U.S. partnership’s ordinary income producing assets such as accounts receivable and inventory.

Prior to the new U.S. tax legislation, a foreign partner generally would not have to pay U.S. tax on capital gain from the sale of a U.S. partnership interest. An exception to this rule required a foreign individual partner to pay U.S. tax on the capital gain from the sale of a U.S. partnership interest if the individual was present in the United States for at least 183 days during the tax year.

Based on the new legislation, a foreign partner, including an individual, is subject to U.S. tax on the gain from the sale of a U.S. partnership interest as ordinary income to the extent of a hypothetical deemed sale of the partnership’s trade or business assets.

The new U.S. tax legislation also includes a new U.S. federal withholding tax requirement on the amount realized from a foreign partner’s sale of a U.S. partnership interest. The amount realized can typically includes cash sale proceeds and the selling partner’s share of any relief from the partnership’s liabilities.

Please contact our international tax specialists for more information regarding how the new U.S. tax legislation may affect you.