By Cynthia

When nonresident aliens (NRAs) and foreign entities invest in U.S. entities, the tax consequences upon liquidating their interests can vary significantly based on whether the investment is in a partnership, corporation, or LLC. Here’s a detailed analysis:

1. Partnership

Investing in a Partnership:

• Pass-Through Entity: Partnerships are typically treated as pass-through entities for tax purposes. This means the partnership itself is not taxed, but the income is passed through to the partners, who report it on their individual tax returns.
• ECI: If the partnership is engaged in a U.S. trade or business, the NRA’s or foreign entity’s share of the income is considered effectively connected income (ECI) and is subject to U.S. taxation.

Liquidating Partnership Interest:

• ECI on Sale: Under IRC Section 864(c)(8), when an NRA or foreign entity sells their partnership interest, the gain attributable to the partnership’s U.S. trade or business is treated as ECI. This means the gain is subject to U.S. tax.
• Withholding Requirements: IRC Section 1446(f)mandates that the buyer withholds 10% of the amount realized on the sale if any portion of the gain is considered ECI.
• Example: If an NRA or foreign entity sells their partnership interest for $1,000,000, and $600,000 is deemed ECI, the buyer must withhold $100,000. The seller must report the $600,000 ECI on their U.S. tax return and pay tax on it.

2. Corporation

Investing in a Corporation:

• Corporate Tax: The corporation itself pays taxes on its income at the corporate tax rate of 21%.
• Dividends: Dividends paid to foreign shareholders are subject to a 30% withholding tax unless reduced by an applicable tax treaty.

Liquidating Corporate Stock:

• Capital Gains Tax: Generally, capital gains from the sale of U.S. corporation stock by an NRA or foreign entity are not subject to U.S. tax unless the corporation owns U.S. real property (USRPI) under IRC Section 897(FIRPTA).
• FIRPTA Withholding: If the corporation owns U.S. real estate, the buyer must withhold 15% of the amount realized on the sale.
• Example: If an NRA or foreign entity sells stock in a U.S. corporation for $2,000,000, and the corporation owns significant U.S. real estate, the buyer must withhold $300,000. If the corporation does not own U.S. real estate, the gain is not subject to U.S. tax.

3. LLC

Investing in an LLC:

• Tax Election: An LLC can choose to be taxed as a partnership or a corporation. If taxed as a partnership, the same rules as above for partnerships apply. If taxed as a corporation, the corporate rules apply.
• ECI: For an NRA or foreign entity investing in an LLC taxed as a partnership, their share of the income from a U.S. trade or business is ECI.

Liquidating LLC Interest:

• As a Partnership: The gain from the sale of an LLC interest taxed as a partnership is treated as ECI if the LLC is engaged in a U.S. trade or business, subject to the same rules and withholding requirements under IRC Section 864(c)(8)and Section 1446(f).
• As a Corporation: If the LLC is taxed as a corporation, the sale of LLC membership interests is treated similarly to the sale of corporate stock, with FIRPTA withholding applying if the LLC owns U.S. real estate.
• Example: If an NRA or foreign entity sells their interest in an LLC taxed as a partnership for $1,000,000, and $600,000 is ECI, the buyer must withhold $100,000. If the LLC is taxed as a corporation and owns significant U.S. real estate, the buyer must withhold 15% of the sale price. If the LLC is taxed as a corporation and does not own significant U.S. real estate, then the capital gains from the sale are not subject to U.S. tax.

Summary

• Partnership: Gain from the sale is ECI, subject to withholding.
• Corporation: Capital gains generally not subject to U.S. tax unless USRPI is involved, with potential FIRPTA withholding.
• LLC: Tax consequences depend on whether the LLC is taxed as a partnership or a corporation, following the respective rules.

Additional Considerations for Foreign Entities

• Tax Treaties: Many countries have tax treaties with the U.S. that can affect withholding rates and tax obligations. Foreign entities should consult these treaties to understand potential benefits and obligations.
• Reporting and Compliance: Foreign entities must ensure proper reporting and compliance with U.S. tax regulations to avoid penalties and ensure efficient tax management.