Tax Trap for Purchasers of Partnership, LLC Interests from Current Holders

The new Tax Code contains many unclear or recently highlighted provisions, but here’s one that caught me by surprise: in an apparent effort to make sure that foreign partners in partnerships that do business in the US pay their US taxes when they sell their partnership interests, the new tax law requires the purchaser of partnership interests from existing foreign owners to withhold and send to the government 10% of the gross proceeds of any such sale.

As all know, this blog site does not give legal advice, and particularly here I repeat that admonition as I am not sure I am categorically correct in the matters described below; take your specific deal to your professional adviser.

This provision applies to all entities taxed as partnerships here in the US; it applies if a foreign entity is engaged directly or indirectly in a trade or business in the US; while withholding applies only to foreign sellers of interests in either of such entities, in order to avoid withholding each purchaser needs to obtain an affidavit from the seller that seller is NOT a foreign seller (until we see regulations, an affidavit should be obtained even if you believe you are 100% certain the seller is a US seller).  The affidavit needs to include a US tax number for the seller.

This applies to LLCs taxed (as most are) as partnerships.  It does not apply to Sub-S corporations which by law cannot have foreign shareholders even if  C-corps are flow-through entities.

Absent regulations, the law seems to apply to redemption.  For PUBLIC investment partnerships such as funds making redemption, there is an IRS notice suspending the provision in SOME cases pending issuance of formal guidance.

If the individual buyer from a foreign seller does not withhold, the entity may be required to do so.

I do not yet understand what happens if an entity sells all its assets and later distributes proceeds.  I do not understand what you do if there is a merger or consolidation of an entity whereby all partners or LLC members receive cash, let alone if they receive stock or debt or property (no cash) or keep a carried forward interest in the emerging reconstituted entity.  Sounds like in all cases you should collect affidavits from everyone, but what happens if someone cannot give an affidavit because in fact they are a non-US person?  Talk to your tax adviser.


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