The IRS generally taxes U.S. taxpayers on all income, from any source derived. Foreign taxpayers, on the other hand, will usually only pay U.S. taxes on income sourced in the U.S. However, under The Foreign Investment in Real Property Tax Act (“FIRPTA”), the IRS treats gain on the disposition of certain U.S. property and interests as if it were “effectively connected” with the conduct of a U.S. trade or business, and thus subject to U.S. tax, even if foreign individuals or businesses are not actually engaged in a U.S. trade or business. (In general, effectively connected income consists of both U.S.-source income and certain types of foreign source income earned by non-resident aliens and foreign corporations engaged in the conduct of a trade or business within the U.S).
Penalties for failure to comply with the IRS provisions can be substantial, so taxpayers and purchasing agents should be aware of these rules if they are involved in such transactions.
The FIRPTA Withholding Tax
The FIRPTA income tax withholding provisions (IRC Section 1445 and related sections) require purchasers or agents acquiring U.S. real property interests (“USRPI)” from foreign persons to withhold 10 percent of the amount realized on the disposition, subject to certain exemptions. In general, a USRPI is any direct interest in parcels of real property located in the U.S., and any interests in a U.S. corporation (such as shares, but not including solely a creditor interest).
The IRS defines “disposition” for this provision to include disposition for any purpose of the Internal Revenue Code, including but not limited to: sales or exchanges, liquidations, redemptions, gifts, transfers, and similar transactions. “Foreign” persons are broadly defined by the IRS, and include nonresident alien individuals, foreign corporations, partnerships, trusts, estates, and foreign branches of U.S. financial institutions if the foreign branch is a qualified intermediary. The “amount realized” generally means the sales or contract price of the property (see IRS rules for more detail).
Upon advance request, the IRS has the authority reduce the 10 percent withholding tax to an amount that will cover the estimated tax liability due, if it is determined that the collection of the amount due under applicable IRS provisions will not be jeopardized by the reduction.
Note that special rules apply for distributions of USPRIs by foreign corporations, partnerships, trusts, or estates, and by certain domestic corporations to foreign shareholders.
In general, various penalties may be imposed under the applicable FIRPTA provisions. Penalties apply for failure to file the required Form 8288 when due and for failure to pay the withholding when due. Additionally, any tax required to be withheld under Section 1445 may be collected, plus interest on the unpaid amount, if the taxpayer fails to do so. Further, a criminal penalty of $10,000 or five years in prison may be imposed under Section 7202 for willful failure to collect and pay over the required tax. Corporate officers or other responsible persons may face separate penalties under Section 6672.
Contact Sherayzen Law Office
This article is intended to give a brief summary of some of the issues concerning, and should not be construed as legal or tax advice. If you have further questions regarding these matters as it pertains to your own tax circumstances, Sherayzen Law Office offers professional advice in all of your tax and international tax needs. Call now at (612) 790-7024 to discuss your tax situation with an experienced business tax lawyer.