What Are the US Tax Requirements for Foreign Partnerships?

There are many ways for US expats to conduct business around the world.  One form of doing business is a foreign partnership. 

This article describes the US tax requirements applicable to foreign partnerships. 

What Is A Foreign Partnership?

For US tax purposes, the Internal Revenue Code generally defines a “partnership” as a syndicate, group, pool, joint venture, or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not a corporation or a trust or estate.

In addition, the Internal Revenue Code generally defines “foreign”, for purposes of a partnership, as a partnership that is not created or organized in the United States or under the law of the United States or of any state in the United States.

How Does A Foreign Partnership Report?

The US tax reporting obligations of a foreign partnership will be determined based on whether the partnership is subject to a general rule or two exceptions to this general rule.

General Rule

A foreign partnership, for US tax purposes, must file Form 1065, “U.S. Return of Partnership Income”, if either:

• The foreign partnership has gross income effectively connected with the conduct of a trade or business within the United States (“effectively connected income”); or
• The foreign partnership has gross income derived from sources in the United States (“US source income”).
• A foreign partnership with effectively connected income or US source income must file Form 1065, even if its principal place of business is outside the United States or all of its partners are foreign persons.

First Exception To General Rule – Foreign Partnerships With US Partners

A foreign partnership is not required to file Form 1065 if:

• The foreign partnership had no effectively connected income during its tax year;
• The foreign partnership had a US source income of $20,000 or less during its tax year;
• Less than one percent of any partnership item of income, gain, loss, deduction, or credit was allocable in the aggregate to direct US partners at any time during its tax year; and
• The foreign partnership is not a withholding foreign partnership (a partnership that has entered into a withholding agreement with the Internal Revenue Service).

Second Exception To General Rule – Foreign Partnerships With No US Partners

A foreign partnership also is not required to file Form 1065 if:

• The foreign partnership had no effectively connected income during its tax year;
• The foreign partnership had no US partners at any time during its tax year;

• All required Forms 1042 (relating to the reporting of tax withheld on certain income of foreign persons, including foreign partnerships and certain payments) and Forms 1042-S (relating to the reporting of certain income, amounts withheld, payments, and distributions) were filed by the foreign partnership or another withholding agent;
• The tax liability of each partner for amounts reportable under Income Tax Regulations Section 1.1461-1(b) and (c) (relating to income tax returns and information returns) has been fully satisfied by the withholding of tax at the source; and
• The foreign partnership is not a withholding foreign partnership.

Principles of US Partnership Taxation 

In understanding the US taxation of foreign partnerships, it is important to note the following two basic principles: 

• Form 1065 is an information return used to report the income, gains, losses, deductions, credits, and other information from the operation of a partnership.  The partnership does not pay tax on its income; and 

• Instead, the partnership passes any income to its partners.  Schedule K-1 to Form 1065 is used by the partnership to report the income to its partners.          

Tax Obligations of US Partners 

A US person who is a partner in a foreign partnership is subject to the general rule that a US citizen is taxable on worldwide income.  Thus, a US person: 

• One who receives a Schedule K-1 reporting income from a foreign partnership filing Form 1065 (as described above) is subject to US taxation on such income; and 

• One who otherwise has income from a foreign partnership is subject to US taxation on such income. 

In addition, a US partner in a foreign partnership can be subject to another tax obligation – Form 8865, “Return of U.S. Persons With Respect to Certain Foreign Partnerships”.   

There are four categories of US persons who are required to file Form 8865: 

Form 8865 – Category 1 Filers 

A Category 1 filer of Form 8865 generally is a US person who controlled the foreign partnership at any time during the partnership’s tax year.  Control of a foreign partnership is ownership of more than a 50% interest in the partnership.   

Form 8865 – Category 2 Filers 

A Category 2 filer of Form 8865 generally is a US person who at any time during the tax year of the foreign partnership, owned a 10% or greater interest in the partnership while the partnership was controlled by US persons each owning at least a 10% interest.    

Form 8865 – Category 3 Filers 

A Category 3 filer of Form 8865 generally is a US person who contributed property during such person’s tax year to a foreign partnership in exchange for an interest in such partnership if such person either owned at least a 10% interest in the partnership immediately after the contribution, or the value of the property contributed (when added to the value of any other property contributed to the partnership by such person during the 12-month period ending on the date of transfer)  exceeds $100,000.     

Form 8865 – Category 4 Filers 

A Category 4 filer of Form 8865 generally is a US person that had a reportable event under Internal Revenue Code Section 6046A (generally certain acquisitions, dispositions, and changes in proportional interests with respect to a foreign partnership) during such person’s tax year.    

Tax Obligations of Foreign Partners 

If a foreign partnership has effectively connected income that is allocable to a foreign partner, the partnership is required to report and pay a withholding tax to the Internal Revenue Service.  Form 8805, “Foreign Partner’s Information Statement of Section 1446 Withholding Tax”, is filed to show a US tax credit allocable to the foreign partner relating to the foreign partnership’s payment of withholding tax.   

Helping Expats with Foreign Partnerships 

Foreign partnerships raise complex US tax issues.  At Greenback Expat Tax Services, we specialize in helping expats manage their US tax obligations.  As part of our services, we have years of experience in assisting expats with foreign partnership issues, and we can help you, too, with your foreign partnership situation. 

Contact us, and one of our customer champions will gladly help. If you need very specific advice on your specific tax situation, you can also click below to get a consultation with one of our expat tax experts.