In our first post on the proposed regulation under section 1446(f), we discussed which party is the withholding agent and outlined the various exceptions to withholding that could apply. Sections 864(c)(8) and 1446(f) were adopted as part of tax reform. Section 864(c)(8) was enacted to reverse the holding of the Tax Court in Grecian Magnesite Mining v. Commissioner, which was affirmed by the U.S. Court of Appeals for the DC Circuit. This post addresses the amount the transferee is required to withhold. Our third post on the proposed regulations under section 1446(f) addresses the withholding requirements and “backstop withholding” rules.

Determining How Much to Withhold

Amount Realized

As noted in the first post, the amount required to be withheld is determined by reference to the transferor’s amount realized on the transfer. The “amount realized” includes the amount of cash paid (or to be paid), the fair market value of other property transferred (or to be transferred), the amount of any liabilities assumed by the transferee or to which the partnership interest is subject, and the reduction in the transferor’s share of partnership liabilities.

When an interest in a PTP is transferred, however, the “amount realized” does not include the transferor’s share of partnership liabilities.

Determining Share of Partnership Liabilities

Because the “amount realized” includes the amount of reduction in the transferor’s share of partnership liabilities, the transferee needs to know the transferor’s share of partnership liabilities. The proposed regulations allow the transferee to rely on a certification of the amount from the transferor as reflected on the most recent Schedule K-1, provided it was issued for a partnership taxable year ending no more than 22 months before the transfer date. The 22-month window has been expanded from the 10-month window provided in Notice 2018-29. In addition, the transferor must certify that it does not have knowledge of any events occurring after receiving the Schedule K-1 that would cause the amount of liabilities to differ by more than 25% from the amount shown on the Schedule K-1.

Additionally, the transferee may also rely on a certification from the partnership that provides the amount of the transferor’s share of partnership liabilities. However, the partnership cannot rely on a Schedule K-1, but must make the determination as of the determination date as defined by the regulations. If the transferee does not obtain a certification from the transferor or the partnership, it must determine the reduction in the transferor’s share of partnership liabilities as of the date of transfer, rather than the determination date.

Limitation on Withholding to Cash and Property

Because the amount realized can include the reduction in the transferor’s share of partnership liabilities, the amount to be withheld could exceed the amount of cash and property to be paid to the transferor. In other cases, the transferee may not know, or have received information pertaining to, the transferor’s share of the partnerships liabilities. The regulations provide relief by allowing the transferee to calculate the amount realized without regard to the decrease in the transferor’s share of partnership liabilities. Effectively, all the cash and the fair market value of any property must be deposited as tax withheld in such a case.

Limitation Based upon the Maximum Tax Liability

To more closely align the amount to withhold with the transferor’s actual tax liability under section 864(c)(8), a transferee may also withhold on an amount declared on a certification from the transferor containing information of the maximum tax liability on the transfer, as long as certain other procedural requirements are fulfilled.

Special Rules for PTPs

The amount realized for PTPs is generally limited to the gross proceeds paid (or credited) to a customer or another broker (rather than taking into account partnership liabilities). If a PTP makes a distribution, the amount realized is the amount of cash and the fair market value of the property distributed.

Coordination with FIRPTA

Determining the Amount Taxable

Section 897(g) treats the sale of a partnership interest in a partnership that owns a U.S. real property interest (“USRPI”) as effectively connected gain or loss from the sale or exchange of a USRPI to the extent such gain or loss is attributable such real property interest. Section 864(c)(8) treats the sale of a partnership interest as effectively connected gain or loss based on a deemed sale by the partnership interest of all of its assets, including a USRPI. To coordinate these rules, the proposed regulations provide that when a partnership holds a USRPI and is also subject to section 864(c)(8), the amount of the effectively connected gain is determined only under section 864(c)(8) and not under 897(g). This rule ensures that the same amount is not subject to tax twice.

Determining the Amount that Must be Withheld

Although the section 897(g) rules do not apply in determining the taxable amount of the effectively connected gain, the proposed regulations under section 1446(f) state that the FIRPTA withholding regime under section 1445 trumps 1446(f).

With respect to partnerships, the section 1445 withholding regime applies only when a partnership owns a substantial USRPI, which requires the partnership to satisfy two tests concurrently. First, 50% or more of the value of the partnership’s gross assets must consist of a USRPI. Second, the combined value of the partnership’s USRPI and its cash and cash equivalents must equal or exceed 90% of the value of the partnership’s gross assets. See Treas. Reg. §§ 1.897T-1(a) and 1.1445-11T(d). Such a partnership is referred to by practitioners as a “50/90 partnership.” In such cases, the proposed regulations would generally apply 15% withholding under section 1445(a), rather than 10% withholding under section 1446(f). If, however, the transferor applies for a withholding certificate from the IRS using Form 8288-B (Application for Withholding Certificate for Dispositions by Foreign Persons of U.S. Real Property Interests) to reduce or eliminate section 1445 withholding, the amount to withhold is the greater of the amounts required under each of the regimes.

Section 1446(f) overrides section 1445 if the transferor has gain under section 897(g) and the partnership is not a 50/90 partnership. Thus, if a partnership is not a 50/90 partnership for which FIRPTA withholding is required, and the partnership has effectively connected gain under section 864(c)(8), then the entire amount realized would be subject to section 1446(f) withholding.