How Does the U.S. Tax Foreign Partners in a U.S. Partnership?
I am a foreign partner in a U.S. partnership with one other partner who is a U.S. citizen. Our partnership, STOLEWAY VENTURES, earned $500,000 in profit effectively connected with its U.S. business. Out of this, $400,000 was earned through our U.S. Permanent Establishment (PE). My share of the profit is $250,000, and $200,000 of it is derived through the U.S. PE. How will the U.S. tax my income if I reside in a non-treaty country like Brazil?
1. General Questions:
- a. How is a foreign partner’s income from a U.S. partnership taxed if the foreign partner resides in a non-treaty country?
- b. How does the U.S. tax income derived through a U.S. Permanent Establishment (PE)?
- c. If I reside in a treaty country, such as Finland, how would my taxation differ based on the U.S.-Finland tax treaty?
- d. What specific article of the U.S.-Finland Treaty impacts the taxation of business profits not attributed to the U.S. PE?
- e. Can you provide the Internal Revenue Code (IRC) sections that govern the taxation of foreign partners in U.S. partnerships?
Answers:
1. Example Scenario Breakdown:
- If you are a foreign partner residing in a non-treaty country like Brazil, the U.S. will tax you on your entire $250,000 share of STOLEWAY VENTURES’ U.S. business income. This includes both the $200,000 derived through the U.S. PE and the remaining $50,000 that is effectively connected with the U.S. business but not through the U.S. PE. The applicable IRC sections are 871(b) and 882, which require foreign persons to be taxed on income effectively connected with a U.S. trade or business.
2. Taxation of Foreign Partners in Non-Treaty Countries:
- a. A foreign partner residing in a non-treaty country, such as Brazil, is taxed on their entire share of U.S. business income. This includes any income effectively connected with a U.S. trade or business, regardless of whether it is derived through a U.S. PE. This is mandated by IRC sections 871(b) and 882.
3. Income Derived Through a U.S. Permanent Establishment (PE):
- b. The U.S. taxes income derived through a U.S. PE based on the income that is attributable to the activities of the PE. This is in accordance with IRC section 864(c), which defines income effectively connected with a U.S. trade or business, including income from a U.S. PE.
4. Taxation Under Treaty Countries:
- c. If you are a resident of a treaty country like Finland, the U.S. taxation of your partnership income may differ. Under Article 7(1) of the U.S.-Finland tax treaty, the U.S. will only tax the income attributable to the U.S. PE. Therefore, only $200,000 of your $250,000 share will be taxed by the U.S., with $50,000 being exempt.
- d. Article 7(1) of the U.S.-Finland tax treaty specifically impacts the taxation of business profits not attributed to the U.S. PE, exempting those profits from U.S. taxation.
5. Relevant Internal Revenue Code (IRC) Sections:
- e. The relevant IRC sections that govern the taxation of foreign partners in U.S. partnerships include:
- IRC §871(b): Tax on nonresident alien individuals.
- IRC §882: Tax on income of foreign corporations connected with U.S. business.
- IRC §864(c): Definition of income effectively connected with a U.S. trade or business.
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