Section 1446 Regulations; Withholding on Effectively-Connected Taxable Income Allocable to Foreign Partners, 28702-28742 [05-9424]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 70, Number 95 (Wednesday, May 18, 2005)]
[Rules and Regulations]
[Pages 28702-28742]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 05-9424]



[[Page 28701]]

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Part III





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1, 301, and 602



Section 1446 Regulations; Witholding on Effectively-Connected Taxable 
Income Allocable to Foreign Partners; Final Rule and Proposed Rule

Federal Register / Vol. 70, No. 95 / Wednesday, May 18, 2005 / Rules 
and Regulations

[[Page 28702]]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 9200]
RIN 1545-AY28, 1545-BD80


Section 1446 Regulations; Withholding on Effectively-Connected 
Taxable Income Allocable to Foreign Partners

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final regulations regarding a 
partnership's obligation to pay withholding tax under section 1446 on 
effectively connected taxable income allocable under section 704 to a 
foreign partner. The regulations interpret the rules added to the 
Internal Revenue Code by section 1246(a) of the Tax Reform Act of 1986 
(1986 Act), as amended by section 1012(s)(1)(A) of the Technical and 
Miscellaneous Revenue Act of 1988 (1988 Act), and section 7811(i)(6) of 
the Omnibus Budget Reconciliation Act of 1989 (1989 Act). The 
regulations will affect partnerships engaged in a trade or business in 
the United States that have one or more foreign partners. The final 
regulations also include conforming amendments to sections 871, 1443, 
1461, 1462, 1463, 6109, and 6721. This document also contains temporary 
regulations under section 1446 that may apply to reduce or eliminate a 
partnership's obligation to pay withholding tax in certain 
circumstances.

DATES: Effective Date: This rule is effective May 18, 2005.
    Applicability Dates: The final and temporary regulations included 
in this document are applicable to partnership taxable years beginning 
after May 18, 2005. However, a partnership may elect to apply the 
provisions of the final regulations to partnership taxable years 
beginning after December 31, 2004. Further, a partnership may elect to 
apply the temporary regulations to partnership taxable years beginning 
after December 31, 2004, provided the partnership also elects to apply 
the final regulations to partnership taxable years beginning after 
December 31, 2004.

FOR FURTHER INFORMATION CONTACT: Ronald M. Gootzeit at (202) 622-3860 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in the final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control numbers 1545-1852 and 1545-1934. Responses to 
these collections of information are required to determine the extent 
to which a partnership is required to pay a withholding tax with 
respect to a foreign partner, to provide information concerning the tax 
paid on such partner's behalf, and to determine the foreign person 
required to report the effectively connected taxable income earned by 
such partnership and entitled to claim credit for the withholding tax 
paid by the partnership. The estimated annual burden per respondent/
recordkeeper for the collections in the final regulation varies from 15 
minutes to 1 hour, depending on individual circumstances, with an 
estimated average of 30 minutes.
    The collections of information contained in the temporary 
regulation have been reviewed, and pending public comment, approved by 
the Office of Management and Budget in accordance with the Paperwork 
Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-
1934. To comment on the collection of information in the temporary 
regulation, please refer to the cross-referenced NPRM (REG-108524-00) 
published elsewhere in this issue of the Federal Register.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    Books or records relating to a collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On September 3, 2003, the IRS and Treasury Department published in 
the Federal Register a notice of proposed rulemaking [REG-108524-00; 
2003-42 I.R.B. 869; 68 FR 52466], corrected at 68 FR 62553 (November 5, 
2003)) under sections 871, 1443, 1446, 1461, 1462, 1463, 6109, and 6721 
of the Internal Revenue Code (Code). The regulations interpret rules 
added to the Code by the 1986 Act, as amended by the 1988 Act and the 
1989 Act. The regulations provide guidance for partnerships required to 
pay withholding tax under section 1446 of the Code (1446 tax). Written 
comments were received in response to the notice of proposed 
rulemaking, and a public hearing was held on December 4, 2003. After 
consideration of all the comments, the proposed regulations under 
sections 871, 1443, 1446, 1461, 1462, 1463, 6109, and 6721 are adopted, 
as revised by this Treasury Decision. The comments received and the 
revisions are discussed below.
    In addition, this document contains temporary regulations that set 
forth rules to reduce or eliminate a partnership's 1446 tax obligation 
with respect to a foreign partner in certain circumstances. 
Specifically, the temporary regulations address when a partnership is 
permitted to consider partner-level deductions and losses when 
computing its 1446 tax (or any installment of such tax) with respect to 
a foreign partner's allocable share of partnership effectively 
connected taxable income (ECTI). The temporary regulations are also 
being issued as proposed regulations in another section of this 
bulletin. The temporary regulations apply to partnership taxable years 
beginning after May 18, 2005. However, a partnership may elect to apply 
the temporary regulations to partnership taxable years beginning after 
December 31, 2004, provided the partnership also elects to apply the 
final regulations to partnership taxable years beginning after December 
31, 2004.

Explanation of Provisions

A. Determining the Status and Classification of Partners--Sec.  1.1446-
1

    Under Sec.  1.1446-1 of the proposed regulations, a partnership 
generally determines the status of its partners based upon Form W-8BEN, 
``Certificate of Foreign Status of Beneficial Owner,'' Form W-8IMY, 
``Certificate of Foreign Intermediary, Flow Through Entity, or Certain 
U.S. Branches for United States Tax Withholding,'' or Form W-9, 
``Request for Taxpayer Identification Number and Certification,'' 
submitted by its partners. A partnership may also rely on other means 
to determine the non-foreign status of its partners, provided that the 
partnership's determination is correct. As described below, several 
commentators suggest that the final regulations permit the submission 
of additional forms to more closely align the section 1446 
documentation requirements with the requirements under the section 1441 
withholding regime.
1. Recognition of Form W-8ECI
    Under section 6.01 of Rev. Proc. 89-31 (1989-1 C.B. 895), as 
modified by

[[Page 28703]]

Rev. Proc. 92-66 (1992-2 C.B. 428), a partnership is required to 
include income subject to a partner's election under section 871(d) or 
section 882(d) (relating to the treatment of real property income as 
effectively connected income) in its computation of partnership ECTI 
when determining its 1446 tax obligation. Rev. Proc. 89-31 also 
provides that if a partner submits Form 4224 (predecessor form to Form 
W-8ECI, ``Certificate of Foreign Person's Claim for Exemption From 
Withholding on Income Effectively Connected With the Conduct of a Trade 
or Business in the United States''), the partner's allocable share of 
income and gain is deemed to be effectively connected income for 
purposes of section 1446 (deemed ECI rule). Under the section 1441 
withholding regime, a payee may provide Form W-8ECI to a withholding 
agent and thereby be exempt from withholding under section 1441 because 
the income paid is effectively connected income to the payee. 
Accordingly, under Rev. Proc. 89-31, a foreign partner that has made an 
election under section 871(d) or section 882(d) can submit Form W-8ECI 
to a partnership to satisfy its documentation requirements under 
section 1441 and section 1446.
    Consistent with Rev. Proc. 89-31, the proposed regulations require 
a partnership to include income subject to a partner's election under 
section 871(d) or section 882(d) in its computation of partnership ECTI 
for purposes of section 1446. However, the proposed regulations do not 
explicitly recognize Form W-8ECI as a form establishing the status of a 
partner. One commentator notes that the deemed ECI rule in Rev. Proc. 
89-31 is useful and provides a clear mechanism for a partnership to 
discharge its 1446 tax obligation. Accordingly, the commentator 
suggests that the final regulations recognize Form W-8ECI and the 
deemed ECI rule for purposes of section 1446.
    Treasury and the IRS agree with the commentator's suggestion. 
Accordingly, the final regulations allow a partner to submit Form W-
8ECI to satisfy the documentation requirements of section 1446. Thus, 
if a partner provides Form W-8ECI to a partnership to claim exemption 
from withholding under sections 1441 and 1442, then the form will be 
accepted for purposes of section 1446, and will operate, consistent 
with the information on such form, to cause the partnership to consider 
the partner's allocable share of income as effectively connected and 
subject to withholding under section 1446.
2. Recognition of Form W-8EXP
    The proposed regulations do not recognize Form W-8EXP, 
``Certificate of Foreign Government or Other Foreign Organization for 
United States Tax Withholding,'' as a form that can establish the 
foreign status of a partner for purposes of section 1446. However, 
under the section 1441 withholding regime, for example, a foreign tax-
exempt organization may submit Form W-8EXP to a payer of income to 
claim that the organization is a foreign tax-exempt organization that 
is exempt from withholding under sections 1441 and 1443(a) because the 
income being paid will not be includible in the organization's 
computation of its unrelated business taxable income (UBTI). One 
commentator notes that a foreign tax-exempt organization may be 
required to provide Form W-8EXP to a partnership for purposes of the 
section 1441 withholding regime, and Form W-8BEN for purposes of the 
section 1446 withholding regime. We note that the same issue exists 
with respect to other foreign persons (e.g., foreign governments) that 
may provide Form W-8EXP for purposes of sections 1441 through 1443. The 
commentator suggests that the final regulations permit a foreign tax-
exempt organization (and other applicable persons) to provide Form W-
8EXP to a partnership to establish the foreign status of such partner 
for purposes of section 1446 to eliminate the circumstances where such 
person has to be ``double documented.''
    The final regulations adopt this suggestion. Treasury and the IRS 
believe that the documentation requirements of sections 1441 and 1446 
should be coordinated where feasible. As a result, a partner seeking to 
be relieved from withholding under sections 1441 through 1443 that 
provides Form W-8EXP to a partnership, will not be required to submit 
an additional form to establish foreign status for purposes of section 
1446. Except with respect to certain tax-exempt organizations described 
in section 501(c) (see part A.5. of this preamble), the submission of a 
Form W-8EXP shall have no effect on whether there is a 1446 tax due 
with respect to such partner's allocable share of partnership ECTI. For 
example, a partnership must still pay 1446 tax with respect to a 
foreign government partner's allocable share of ECTI because such 
partner is treated as a foreign corporation under section 892(a)(3).
3. Acceptable Substitute Form for Identification of Partners
    As noted above, the proposed regulations permit a partnership to 
use other means to ascertain the non-foreign status of its partners, 
provided that the partnership is correct in its determination. Further, 
under the proposed regulations, a partnership must generally presume 
that a partner that does not furnish a Form W-8BEN, Form W-8IMY, or 
Form W-9 is a foreign person. One commentator requests that the final 
regulations permit a partnership to use a substitute form to identify 
its partners, provided the information given to the partnership is 
substantially the same as that found on the above-mentioned forms.
    Treasury and the IRS agree with the commentator's proposed change 
to the extent that the section 1441 regime would generally permit the 
acceptable substitute form. As a result, the final regulations adopt 
this comment and permit a partnership or nominee required to pay 1446 
tax to develop its own form, consistent with Sec.  1.1441-1(e)(4)(vi), 
to serve as its substitute form upon which partners will submit 
information.
4. Clarification of Miscellaneous Documentation Issues
    Several commentators request that the final regulations clarify 
certain issues regarding a partnership's obligation to identify its 
foreign partners. One commentator requests that the final regulations 
address a partnership's duty, if any, to inquire as to whether a 
partner has made an election under section 871(d) or 882(d), or whether 
the partner is a dealer in securities. As described in part A.1. of 
this preamble, the proposed regulations provide that income subject to 
a partner's election under section 871(d) or 882(d) shall be considered 
in the partnership's computation of the partner's allocable share of 
partnership ECTI. Further, the proposed regulations require a partner 
that has made an election under section 871(d) or section 882(d) to 
notify the partnership that the election has been made so that the 
partnership can correctly determine the partner's allocable share of 
ECTI. The proposed regulations do not address when a partner is a 
dealer.
    The final regulations retain the requirement that a partner notify 
the partnership of an election it has made (or will make) under section 
871(d) or section 882(d). Further, to the extent that an election has 
been made, the partner is required to provide the partnership a copy of 
such election. However, the final regulations do not

[[Page 28704]]

explicitly require a partner to notify the partnership that it is a 
dealer. Further, the final regulations do not impose an affirmative 
duty on the partnership to inquire as to a partner's status as a dealer 
or whether an election under section 871(d) or section 882(d) has been 
made.
    Another commentator requests clarification regarding the ability of 
a lower-tier partnership (LTP) to use other means to identify partners 
of an upper-tier partnership (UTP). Under proposed regulation Sec.  
1.1446-5, an LTP may be required to look through a UTP to the partners 
of such partnership if adequate documentation is provided to the LTP 
and the LTP can reliably associate (within the meaning of Sec.  1.1441-
1(b)(2)(vii)) all or a portion of the UTP's allocable share of ECTI 
with one or more partners of the UTP. To the extent that a UTP has not 
provided adequate documentation as to the status of its partners to the 
LTP, the LTP is to treat the UTP as an entity and withhold at the 
highest applicable rate under section 1446(b). In this regard, the 
regulations cross reference proposed regulation Sec.  1.1446-1(c)(3), 
which allows a partnership to rely on other means to determine the non-
foreign status of its partners, provided that the partnership is 
correct in its determination. The commentator requests clarification as 
to whether an LTP that has not received adequate documentation from a 
UTP regarding the status of one or more partners of the UTP may, 
nevertheless, rely on other means to determine that certain partners of 
the UTP are U.S. persons.
    In response to the commentator's question, the final regulations 
remove the cross reference to Sec.  1.1446-1(c)(3). The look-through 
rules of Sec.  1.1446-5 are intended to be consistent with the section 
1441 regulations and the concept of reliable association through 
documentation. Accordingly, an LTP may not rely on other means and look 
through a UTP to the partners of the UTP to the extent that the UTP has 
failed to provide adequate documentation regarding the status of its 
partners. Rather, to the extent the documentation submitted is 
insufficient to permit the LTP to look through, the LTP is to treat the 
UTP as a foreign entity and pay 1446 tax at the higher of the rates in 
section 1 or section 11.
    Another commentator notes that proposed regulation Sec.  1.1446-1 
provides that a foreign partnership is treated as a foreign partner 
under section 1446(e). The commentator then notes that Sec.  1.1446-5 
of the proposed regulations provides that all or a portion of the 
allocable share of a UTP shall be treated as allocable to the partners 
of the UTP to the extent that the LTP can reliably associate the ECTI 
allocable to the UTP with the partners of such partnership. The effect 
of this rule is that for purposes of the LTP's 1446 tax computation, 
the UTP is not treated as the partner of the LTP. The commentator 
requests clarification regarding coordination of the above two sections 
of the proposed regulations. We note that the issue the commentator 
raises also arises under the proposed regulations with respect to 
trusts part or all of which are treated as owned by a grantor or other 
owner under subpart E of Subchapter J of the Code.
    In response to this question, Sec.  1.1446-1 of the final 
regulations includes a cross reference to Sec.  1.1446-5 and language 
clarifying that the partners of a UTP are considered the direct 
partners of an LTP only to the extent the LTP is applying the look 
through rules of Sec.  1.1446-5 in computing its 1446 tax obligation. 
This treatment is only for purposes of computing the LTP's 1446 tax 
liability and has no effect on LTP's reporting. Thus, whether or not an 
LTP computes its 1446 tax by looking through a UTP, the LTP shall 
furnish Form 8805 with respect to the 1446 tax it pays to and in the 
name of the UTP so that such UTP may then, in turn, take such amounts 
into account in computing its 1446 tax obligation. UTP will then claim 
a credit for the 1446 tax LTP paid and will allocate the credit to its 
partners (or claim a refund), as appropriate, and report the allocation 
of the tax on the Forms 8805 it furnishes to its foreign partners. 
Similarly, the final regulations clarify that a grantor or other owner 
under subpart E of subchapter J of the Code of a domestic or foreign 
trust is the beneficial owner of income and it (rather than the trust) 
is considered the partner only for purposes of computing the 
partnership's 1446 tax liability.
5. Coordination With Section 1443 and Foreign Tax-Exempt Organizations
    Section 1443(a) provides that withholding under chapter 3 of the 
Code shall apply to income includible under section 512 in computing 
the UBTI of a foreign organization subject to the tax imposed by 
section 511 only to the extent and subject to such conditions as may be 
provided by regulations. The proposed regulations provide that if an 
amount is allocable from a partnership to an entity described in 
section 1443(a), then the partnership must withhold under section 1446. 
One commentator notes that section 1443(a) only applies to the extent 
that an item of income is includible in the computation of UBTI, and 
that the proposed regulations fail to recognize that some income items 
comprising part of the partnership's ECTI will not be includible by a 
partner in computing its UBTI. See Sec. Sec.  1.512(b)-1 and 1.512(c)-
1. Further, the commentator notes that in the context of section 1441, 
section 1443(a) is enforced by a presumption contained in Sec.  1.1441-
9(b)(3) that income will be includible in computing a foreign tax-
exempt organization's UBTI if the documentation the payee provides is 
unreliable or is lacking, and that the final regulations should include 
a similar presumption in the case of section 1446 with respect to 
foreign tax-exempt partners.
    In response to the commentator's suggestions, the final regulations 
clarify that only the portion of a tax-exempt partner's allocable share 
of partnership ECTI that is includible in the partner's computation of 
UBTI is subject to section 1446. The final regulations also provide 
that the procedures in Sec.  1.1441-9 for claiming an exemption from 
withholding under section 1441 will apply for claiming an exemption 
from withholding under section 1446. Under those procedures, the 
organization may specify the portion of its allocable share of 
partnership income that will not be includible in the organization's 
computation of its UBTI. Thereafter, the partnership may determine that 
a partner's representation as to amounts not includible in the 
organization's UBTI is unreliable or lacking. If such a determination 
is made, the partnership must then presume, consistent with Sec.  
1.1441-9(b)(3) as applied for purposes of section 1446, that the 
partnership item will be includible in computing the partner's UBTI.
    In response to another comment, the language of the final 
regulations has been changed to follow more closely the language of 
section 1443(a) and the regulations thereunder.
6. Corresponding Changes to Forms
    The IRS intends to modify several forms (e.g., Forms W-8, 8804, 
8805, 8813) to accommodate the adoption of the final and temporary 
regulations set forth in this document. Until such time as the forms 
are modified, partners, nominees, and partnerships may use the current 
version of a form and attach a statement to such form, to the extent 
necessary, to explain the use of the form for purposes of section 1446.

[[Page 28705]]

B. Determining a Foreign Partner's Allocable Share of Partnership 
ECTI--Sec.  1.1446-2

1. Cancellation of Indebtedness Income and Gain From Foreclosure and 
Deed in Lieu of Foreclosure
    The proposed regulations requested comments on the appropriate 
treatment under section 1446 of partnership cancellation of 
indebtedness income (COD). Several comments, discussed below, were 
received.
    One commentator suggests that a partnership should be relieved of 
its 1446 tax obligation with respect to COD income allocable to foreign 
partners provided the partnership files with the IRS an explanatory 
statement that substantiates its financial hardship. A second 
commentator cites the rules set forth in Sec.  1.1445-2(d)(3), 
applicable to a foreclosure that results in a disposition of a United 
States real property interest. Consistent with Sec.  1.1445-2(d)(3), 
the commentator proposes that so long as the partnership receives no 
cash or other property as part of the cancellation of indebtedness or 
the foreclosure on property (or deed in lieu of foreclosure), income 
attributable to such amounts should be excluded from partnership ECTI 
and the partnership should not be required to withhold on such amounts. 
However, the commentator states that to the extent that the partnership 
makes a distribution within the same taxable year that the COD income 
or gain arising from a foreclosure (or deed in lieu of foreclosure) is 
realized, the partnership ECTI for the year of realization should 
include the COD income or gain from foreclosure up to the amount of the 
distribution. Finally, one commentator focuses on a partnership in a 
Chapter 11 bankruptcy proceeding and cites a potential conflict between 
the deemed distribution rule of section 1446(d) and the prohibition on 
preferential treatment of non-creditors found in the Bankruptcy Code. 
This commentator recommends that a partnership in a Chapter 11 
bankruptcy proceeding that incurs COD income should be relieved from 
paying 1446 tax on such income.
    Treasury and the IRS believe that section 1446 requires a 
partnership to pay 1446 tax on COD income and gain recognized by reason 
of a foreclosure or deed in lieu of foreclosure on property when such 
income or gain is allocated to foreign partners. The purpose of the 
statute is to collect taxes that foreign persons may not otherwise pay, 
regardless of the liquidity or financial situation of the withholding 
agent. Further, unlike section 1441, section 1446 does not require that 
a partnership have control, receipt, custody, disposal, or payment over 
the income that is subject to withholding. As a result, no exception is 
mandated. In addition, Treasury and the IRS do not believe that a 
deemed distribution under section 1446(d) would violate any provisions 
of the Bankruptcy Code. Accordingly, the final regulations do not adopt 
the commentators' suggestions regarding COD income or gain arising from 
the foreclosure (or deed in lieu of foreclosure) on property. However, 
Treasury and the IRS are issuing temporary and proposed regulations 
that permit a foreign partner, in certain circumstances, to certify to 
the partnership that it has deductions and losses it reasonably expects 
to be available to reduce the partner's U.S. income tax liability on 
the partner's allocable share of effectively connected income or gain 
from the partnership. This certification procedure may apply to reduce 
the partnership's 1446 tax obligation with respect to COD income 
allocable to a foreign partner in appropriate circumstances. Treasury 
and the IRS believe that this approach, which is consistent with the 
statute and legislative history, appropriately balances the interests 
of taxpayers and the government.
2. Consideration of a Foreign Partner's Deductions and Losses in 
Computing the Partner's Share of Partnership ECTI
    See Sec.  1.1446-6T and part G. of this preamble regarding when a 
partnership may consider partner-level deductions and losses in 
determining its 1446 tax due with respect to a partner.

C. Calculating, Paying Over, and Reporting the 1446 Tax--Sec.  1.1446-3

1. Applicable Percentage for Computing 1446 Tax
    The proposed regulations require a partnership to pay withholding 
tax (1446 tax) using the highest rate of tax specified in section 1 
(with respect to ECTI allocable to a non-corporate foreign partner) or 
section 11(b)(1) (with respect to ECTI allocable to a corporate foreign 
partner). Several commentators note that the proposed regulations 
effectively require a partnership to pay 1446 tax in excess of a 
partner's actual tax liability because the partnership is not permitted 
to consider preferential tax rates that apply to long-term capital gain 
or other special items of income or gain at the partner-level (e.g., 
unrecaptured section 1250 gain). The commentators note that at the time 
that Congress enacted and amended section 1446 there was no difference 
between the tax rate for capital gains and ordinary income and, 
therefore, section 1446 should not be read to prohibit consideration of 
the highest rate that may apply to special items of income or gain. The 
commentators request that the final regulations permit a partnership to 
consider the character of income or gain allocable to a foreign partner 
and pay 1446 tax at the highest rate applicable to the type of income 
or gain allocable to a foreign partner.
    Treasury and the IRS have carefully considered these comments and 
generally believe that permitting a partnership to consider the highest 
rate of tax associated with particular partnership items of income and 
gain is a reasonable approach under the statute that would reduce the 
instances of overwithholding without undermining the purpose or 
effectiveness of the statute. In response, the final regulations 
provide that while a partnership is generally required to use the 
highest rate of tax in section 1 or section 11 (currently 35 percent) 
applicable to a partner, it may also consider (subject to exceptions 
discussed below) the type of income or gain allocable to a foreign 
partner during the taxable year when computing its 1446 tax obligation. 
As a result, a partnership can generally pay 1446 tax using the highest 
capital gains rate (currently 15 percent) to the extent long-term 
capital gain is allocable to a non-corporate foreign partner. 
Similarly, the highest rate of tax for collectibles gain under section 
1(h)(6) (currently 28 percent) may generally be considered when such 
gain is allocable to a non-corporate foreign partner. Further, a 
partnership can generally pay 1446 tax using the maximum tax rate for 
unrecaptured section 1250 gain (currently 25 percent) to the extent 
such gain is allocable to a non-corporate foreign partner. When 
applicable, the partnership must use the highest preferential rate for 
a particular type of income or gain without regard to the amount of the 
foreign partner's allocable share of such income or gain, or the 
foreign partner's other income.
    As discussed above, several preferential rates depend upon the 
status of the person (corporate or non-corporate) allocated the income 
or gain (e.g., long-term capital gain). Further, in some circumstances 
under the final regulations documentation may be lacking as to the 
corporate or non-corporate status of a partner. Accordingly, the final 
regulations include a rule that prohibits a partnership from using a 
preferential rate in computing its 1446 tax on income or gain allocable 
to a foreign partner where the preferential rate depends upon the 
corporate or non-

[[Page 28706]]

corporate status of the partner and either such status has not been 
established by documentation or the regulations otherwise instruct the 
partnership to pay 1446 tax at the higher of the applicable rates in 
section 1446(b).
    For example, under Sec.  1.1446-1(c)(3) a partnership that has not 
received documentation from a partner must presume that the partner is 
a foreign person, unless the partnership relies on other means to 
determine the non-foreign status of the partner. Further, the 
regulations instruct that if the partnership knows that the partner is 
an individual, then the partnership must pay 1446 tax using the 
applicable percentage appropriate for a non-corporate foreign partner 
(highest rate in section 1). Notwithstanding the foregoing, under the 
rule in the final regulations, the partnership may not consider the 
preferential rate applicable to any net long-term capital gain 
allocable to such partner because the preferential rate applicable to 
that type of gain depends on the status of the person reporting such 
gain, and the partner has failed to provide documentation in accordance 
with Sec.  1.1446-1.
    Similarly, under Sec.  1.1446-5 a partnership may not be able to 
reliably associate 100 percent of an upper-tier partnership's allocable 
share of ECTI with the partners of the upper-tier partnership. In such 
circumstances, Sec.  1.1446-5(c)(2) requires the lower-tier partnership 
to pay 1446 tax on the portion it cannot reliably associate with 
partners of the upper-tier partnership at the higher of the rates in 
section 1446(b). Even though the upper-tier partnership has provided 
documentation on its own behalf (e.g., Form W-8IMY), and the lower-tier 
partnership therefore knows that the upper-tier partnership is a non-
corporate entity, the lower-tier partnership may not consider any 
preferential rate when computing its 1446 tax due on the portion of the 
ECTI the lower-tier partnership cannot reliably associate with partners 
of the upper-tier partnership.
2. Deemed Cash Distributions Under Section 1446(d)
    Section 1446(d) states that, except as provided in regulations, a 
partnership's payment of 1446 tax with respect to a foreign partner is 
treated as a distribution to the partner on the earlier of the day the 
partnership paid the tax or the last day of the partnership's taxable 
year for which such tax was paid. The legislative history provides that 
the above rule may be altered by regulations to account for mid-year 
dispositions of partnership interests. See H.R. Rep., 101-247, 101st 
Cong., 1st Sess. (Sept. 20, 1989). Under Rev. Proc. 89-31 (1989-1 C.B. 
895), if the 1446 tax is paid in a subsequent taxable year with respect 
to ECTI allocable to the preceding taxable year, the deemed 
distribution is considered to have occurred on the last day of the 
preceding taxable year or the last day during such year that the person 
was a partner. The proposed regulations follow the rules outlined 
above.
    Several commentators note that the deemed distribution under 
section 1446(d) may cause a partner to recognize gain under sections 
731 and 741. Under section 731, a partner recognizes gain on a 
partnership distribution only to the extent the partner receives cash 
in excess of its basis in the partnership. To the extent a partner 
receives cash in excess of the partner's basis in its partnership 
interest, section 731 considers the partner to have engaged in a sale 
or exchange of the interest, the tax consequences of which are 
described in section 741. Under section 1446(d), if the partnership is 
deemed to distribute cash during the taxable year (i.e., on the date 
the 1446 tax is paid), before the date that the partner may consider an 
increase in the partner's basis in the partnership under section 705 
for income allocable from the partnership for the entire taxable year, 
then the partner may recognize gain under sections 731 and 741.
    One commentator proposes that, for purposes of section 1446(d), a 
partnership should look to the partnership agreement to determine 
whether a distribution under section 1446(d) has occurred. 
Specifically, the commentator states that a partnership should not 
treat a payment of 1446 tax on behalf of a foreign partner as a deemed 
distribution under section 1446(d) to the extent the partnership 
agreement prohibits a distribution to the partner, or the partner is 
required to pay back to the partnership part or all of the 1446 tax 
paid on the partner's behalf. The commentator suggests that the 
regulations should consider both explicit provisions of the partnership 
agreement that require a foreign partner to contribute to the 
partnership an amount equal to the 1446 tax the partnership paid on 
behalf of the partner and provisions that have the effect of requiring 
a contribution, though not explicitly referring to section 1446.
    Another commentator suggests that a deemed distribution under 
section 1446(d) that results from a partnership's installment payment 
of 1446 tax should be considered an advance or drawing against a 
partner's distributive share of income within the meaning of Sec.  
1.731-1(a)(1)(ii) and treated as a current distribution made on the 
last day of the partnership taxable year with respect to such partner. 
Adopting this suggestion would reduce the likelihood of a foreign 
partner recognizing gain because the deemed distribution would be 
measured against the partner's basis in its partnership interest after 
the partner's basis has been increased for income allocable to the 
partner for the partnership's taxable year under section 705.
    A third commentator notes a conflict with the deemed distribution 
rule in the context of a partnership in bankruptcy. See discussion at 
Part B.1. of this preamble.
    Treasury and the IRS believe that deemed distributions under 
section 1446(d) should not unnecessarily result in a foreign partner 
having to recognize gain under sections 731 and 741, and that the 
deemed distributions should be treated consistently with other 
distributions under subchapter K. Further, section 1446(d) provides 
Treasury and the IRS with explicit authority to alter the rules to 
accomplish the objectives of the section. Accordingly, the final 
regulations generally provide that a deemed distribution under section 
1446(d) is treated as an advance or drawing within the meaning of Sec.  
1.731-1(a)(1)(ii) against the partner's distributive share of income 
from the partnership. See also Rev. Rul. 94-4 (1994-1 C.B. 195). As a 
result, the tax ramifications of a partnership's payment of 1446 tax on 
a foreign partner's allocable share of ECTI will be considered by the 
partner at the end of the partnership's taxable year, or the last day 
of the partnership's taxable year during which such person was a 
partner in the partnership. The advance or drawing treatment applies 
only to installment payments of 1446 tax made during the partnership's 
taxable year with respect to ECTI earned in the same taxable year. Any 
1446 tax paid after the close of the partnership's taxable year, 
including amounts paid with the filing of Form 8804, ``Annual Return 
for Partnership Withholding Tax (Section 1446),'' that are on account 
of partnership ECTI allocated to partners for the prior taxable year 
shall be treated under section 1446(d) and the regulations as a 
distribution from the partnership on the earlier of the last day of the 
partnership's prior taxable year for which the tax is paid, or the last 
day in such prior taxable year on which such foreign partner held an 
interest in

[[Page 28707]]

the partnership. The rules in the final regulations apply only for 
purposes of determining the tax ramifications of the deemed 
distribution to a foreign partner under sections 705, 731, and 733, and 
do not affect the date that the partnership (or partner) is otherwise 
considered (or deemed) to have paid tax for purposes of section 6654 
and section 6655.
    The final regulations do not adopt the suggestion that a deemed 
distribution under section 1446(d) should occur only to the extent the 
partnership agreement permits a distribution to the foreign partner and 
does not require the foreign partner to contribute an amount to the 
partnership. Treasury and the IRS believe that the suggestion is 
inconsistent with section 1446(d) and the treatment of distributions 
under subchapter K of the Code. To the extent that 1446 tax has been 
paid on behalf of a partner and a Form 8805 has been issued to a 
partner, section 1446(d) requires that such amount be treated as a 
distribution. Further, such an approach would not be administrable 
because it would require the IRS to review each partnership agreement 
and interpret the provisions of the agreement for purposes of section 
1446. Moreover, Treasury and the IRS are concerned that the suggested 
approach would inappropriately result in different treatment for 
similarly situated foreign partners.
3. Overlap Between Section 1445 and 1446
    The proposed regulations provide that when section 1445 and section 
1446 both technically apply, a partnership is required to pay 
withholding tax on behalf of its foreign partners in accordance with 
section 1446. This rule, referred to as the trumping rule, primarily 
relates to a domestic partnership's disposition of a United States real 
property interest within the meaning of section 897, which is subject 
to withholding under section 1445(e)(1). The proposed regulations also 
permit a foreign partnership to credit the amount withheld by a 
transferee under section 1445(a) when computing its 1446 tax 
obligation.
    Several commentators note that the trumping rule has the effect of 
prohibiting a partnership and/or its partners from seeking a 
certificate from the IRS, where appropriate, that would reduce 
withholding to an amount more closely related to a partner's actual tax 
liability on the gain allocated. See Rev. Proc. 2000-35 (2000-2 C.B. 
211 Sec.  8.01). As a result, several commentators suggest that the 
final regulations remove the trumping rule and modify the section 1445 
withholding certificate program so that partnerships and partners 
subject to section 1446 can consider anticipated current year 
deductions and losses and obtain withholding certificates to reduce the 
withholding tax otherwise required to be paid. In addition, one 
commentator requests clarification of the consequences for failure to 
comply with section 1446 under the trumping rule.
    After consideration of the comments described above, the trumping 
rule is retained in the final regulations. Treasury and the IRS do not 
believe Congress intended for section 1445 to apply to the exclusion of 
section 1446 where the sections overlap. Treasury and the IRS believe 
that with the changes made in the final regulations (e.g., 
consideration of the character of income allocable to a foreign 
partner, see part C.1. of this preamble) and the issuance of the 
temporary regulations that permit foreign partners to certify available 
deductions and losses to a partnership, the section 1446 withholding 
regime will, in most circumstances, arrive at a withholding result that 
approximates the result that would otherwise be reached under section 
1445. The final regulations clarify that a partnership that fails to 
comply with section 1446 under the rule described above may be subject 
to all additions to the tax, interest, and penalties that otherwise 
apply to a failure to pay 1446 tax.
4. Notice to Foreign Partners of 1446 Tax Paid by Partnership
    The proposed regulations require a partnership that pays 1446 tax 
on behalf of a foreign partner to notify the partner when a payment of 
tax has been made. Because the 1446 tax installment due dates are the 
15th day of the 4th, 6th, 9th, and 12th months of the partnership's 
taxable year, a partnership must generally notify a foreign partner 
four times during the taxable year of the 1446 tax paid on the 
partner's behalf. The notice provided during the taxable year of the 
1446 tax paid is not required to be in any particular form but must 
contain, among other items, information sufficient to identify the 
partnership, the partner, the annualized amount of ECTI estimated to be 
allocated to the partner, and the amount of 1446 tax paid to the IRS on 
behalf of the foreign partner.
    After the close of the partnership taxable year, the partnership is 
required to file Forms 8804 and 8805 with the IRS and to provide a Form 
8805 to each foreign partner. The Form 8805 furnished to a foreign 
partner will set forth the 1446 tax paid on the partner's behalf for 
the entire taxable year. Each foreign partner receiving a Form 8805 
from the partnership is generally permitted to claim a tax credit under 
section 33 on its U.S. Federal income tax return in the amount shown on 
the form as paid on the partner's behalf. When completing its Form 8804 
and Form 8805, the partnership will use the actual results of the 
partnership's operations for the previous year. When completing its 
Form 8804, if the partnership determines that its 1446 tax is an amount 
greater than previously estimated, the partnership is required to pay 
any shortfall when filing the form.
    One commentator submits that it is administratively burdensome and 
costly to require a partnership to notify its foreign partners four 
times during the year when each installment of 1446 tax is paid on 
their behalf. The commentator also contends that it is burdensome on a 
partnership to have to explain to each foreign partner any discrepancy 
between the four notices provided during the taxable year, which are 
based on estimates, and the Form 8805 issued after the close of the 
taxable year, which is based on the partnership's actual operating 
results. Finally, the commentator contends that it is burdensome, 
costly, and inefficient in large non-publicly traded partnerships, 
where the net income to be allocated to a partner is often small, to 
have to provide notice to thousands of foreign partners four times 
during the taxable year and again after the taxable year.
    A second commentator makes two points concerning the requirement 
that a partnership provide notice during the taxable year for each 1446 
tax installment payment. First, the commentator suggests that because 
the section 1446 tax rate is the highest rate applicable to a foreign 
partner, most foreign partners do not need notice during the taxable 
year because they already assume the partnership's 1446 tax installment 
payments will exceed any estimated tax they might otherwise owe on 
their allocable share of ECTI. Second, the commentator submits that in 
practice the notices are often not received before a foreign partner's 
estimated tax due date for the same period and, therefore, provide 
little or no benefit to the foreign partner.
    Both commentators propose that unless a foreign partner requests 
information for each installment payment of 1446 tax, a partnership 
should only be required to report to the foreign partner the amounts 
paid to the IRS on behalf of the partner after the close of the taxable 
year on Form 8805.

[[Page 28708]]

    Treasury and the IRS believe that the notice requirement in the 
proposed regulations serves the useful function of advising a foreign 
partner of amounts paid on its behalf. The notice may aid a partner in 
computing its estimated tax liability either for the same installment 
period or a subsequent installment period during the taxable year. This 
is particularly true where the estimated tax payment dates of the 
foreign partner do not coincide with the 1446 tax installment dates. 
See section 6654(j). Based upon the foregoing, the final regulations 
retain the notice requirement set forth in the proposed regulations.
    However, Treasury and the IRS recognize that situations may exist 
where the notice requirement is particularly burdensome. Accordingly, 
the final regulations contain two exceptions to the requirement that 
the partnership provide notice during its taxable year as it pays each 
installment of 1446 tax. First, where an agent of the partnership 
charged with providing notice to the foreign partners of the 
partnership during the taxable year for each installment of 1446 tax is 
the same person that also acts as an agent on behalf of a foreign 
partner for purposes of filing the foreign partner's U.S. income tax 
return, the notice requirement is deemed to be satisfied with respect 
to such partner. Second, a partnership with 500 or more foreign 
partners is not required to provide notice to a foreign partner of 
amounts paid on such partner's behalf during the course of the taxable 
year, unless requested, if the partnership estimates that the 1446 tax 
on such partner's allocable share of partnership ECTI is less than 
$1,000. If one of the exceptions applies to a foreign partner for an 
installment payment of 1446 tax, then the partnership is not required 
to provide notice of the installment payment (and the tax paid on the 
partner's behalf) unless requested by the partner. However, in all 
events, the partnership is required to provide notice of the tax paid 
on the partner's behalf after the close of the taxable year by issuing 
Form 8805 to the partner.
5. Refunds by Partnership for Amounts Withheld
    Under the proposed regulations, a partnership is entitled to obtain 
a refund for 1446 tax paid over to the IRS only if a refund is 
permissible under section 1464 and the regulations thereunder. The 
position in the proposed regulations varies from the position in Rev. 
Proc. 92-66, which permits a partnership to obtain a refund of 1446 tax 
to the extent an amount paid to the IRS is not reflected on a Form 8805 
issued to a partner for the taxable year. One commentator notes that 
because actual operating results can vary significantly from the 
estimates the partnership uses during the year to calculate its 1446 
tax, withholding in excess of the partner's actual tax liability can 
occur. That is, where a partnership annualizes its income under one of 
the accepted methods but events occur that are not taken into account 
until the partnership files its Form 8804, and such events have the 
effect of reducing or eliminating the 1446 tax otherwise due, the 
partnership should be entitled to a refund of the overpaid amounts. The 
commentator proposes that the final regulations adopt the refund system 
set forth in Rev. Proc. 92-66.
    In response to the commentator's suggestion, the final regulations 
adopt the position taken in Rev. Proc. 92-66 with respect to refunds to 
withholding agents, thereby permitting non-publicly traded partnerships 
subject to section 1446 to obtain refunds for 1446 tax paid to the IRS 
to the extent that the amounts are not reflected on a Form 8805 issued 
to a partner. Publicly traded partnerships (and nominees) required to 
pay 1446 tax based on distributions of effectively connected income 
will continue to be subject to section 1464 and the regulations 
thereunder. The standard in the regulation is intended to follow the 
approach set forth in Rev. Proc. 92-66 in all respects.
6. Additions to the Tax, Interest and Penalties for Noncompliance With 
Section 1446
i. In General
    The proposed regulations provide that if a partnership fails to 
file and pay its 1446 tax, but a partner files a U.S. Federal income 
tax return for the taxable year and pays all tax required to be shown 
on that return, then the partnership is deemed to have filed Forms 8804 
and 8805 and paid its 1446 tax with respect to such foreign partner as 
of the date that the partner satisfied the aforementioned conditions. 
Therefore, the proposed regulations contain a deemed filing and payment 
rule applicable to a partnership that is based upon a foreign partner 
completing two actions: (1) Filing its U.S. Federal income tax return, 
and (2) paying all tax required to be shown on such return. Treasury 
and the IRS have modified the deemed filing and payment rules in the 
final regulations to better coordinate section 1446 with section 1463, 
as well as with any additions to the tax, interest, and penalties that 
may apply.
    First, the final regulations modify the rule in the proposed 
regulations that deems a partnership to have paid 1446 tax with respect 
to a partner. As modified, the final regulations make a partnership's 
deemed payment dependent only on the partner's payment of all the tax 
the partner is required to pay, and disregard the partner's actual 
filing of a U.S. Federal income tax return. As modified, the deemed 
payment rule is consistent with general principles of when a tax is 
considered paid.
    Second, the final regulations remove the deemed filing rule in the 
proposed regulations because of the administrative difficulties in such 
cases where there are multiple foreign partners. Therefore, under the 
final regulations, a partnership will not be deemed to have filed Forms 
8804 and 8805 at any time. As a result, once the failure to file 
penalty under section 6651(a)(1) begins to accrue, as discussed below, 
a partnership may affirmatively stop the accrual of the penalty only by 
filing Form 8804.
    Third, the final regulations clarify the date upon which a 
partnership will be deemed to have paid 1446 tax under the deemed 
payment rule. The rule applies for purposes of sections 1446, 1461, 
1463, 6601, 6651, 6655, and any other penalties or additions to the tax 
that may apply. The rule provides that a partnership will be deemed to 
have paid the 1446 tax associated with ECTI allocable to a particular 
partner on the later of the date that the partner is considered to have 
paid all its tax under section 6513(a) and (b)(2) (prescribing the date 
tax is considered paid for purposes of sections 6511(b)(2), (c), and 
6512), or the last date for paying the 1446 tax without extensions (the 
unextended due date for Form 8804). In application, the rule ensures 
that a partner's payments of estimated tax will have no effect on the 
computation of the partnership's underpayment addition to the tax under 
section 6655 and Sec.  1.1446-3 of the regulations.
    Fourth, the final regulations change the method required for a 
partnership to show that a partner has paid all tax required to be 
shown on the partner's U.S. Federal income tax return. In response to 
one commentator, the final regulations adopt the method set forth in 
Sec.  1.1445-1(e)(3) because such method is more familiar and easier 
for partnerships to apply than obtaining Form 4669, ``Statement of 
Payments Received,'' the method set forth in the proposed regulations. 
Under the final regulations, a partnership must provide sufficient 
information for the IRS to

[[Page 28709]]

determine that the partner's tax liability was satisfied or established 
to be zero.
    More specific discussion of various additions to the tax, interest, 
and penalties is provided below.
ii. Current Year Safe Harbor Under Section 6655 and Sec.  1.1446-3
    Section 1446 imposes a withholding regime that applies the 
principles of section 6655, as modified by these regulations. Under 
section 6655, a corporation is not liable for an underpayment addition 
to the tax if the corporation pays 25 percent of either the preceding 
year's or the current year's tax liability in each quarterly 
installment. These safe harbors are often referred to as the prior year 
safe harbor and the current year safe harbor. The proposed regulations 
provide for a modification of the prior year safe harbor that is 
consistent with Rev. Proc. 89-31, but do not mention the potential 
application of the current year safe harbor. The final regulations 
clarify that the current year safe harbor of section 6655(d)(1)(B)(i) 
can apply to a partnership subject to section 1446. Further, the final 
regulations retain the language in the proposed regulations that sets 
forth the prior year safe harbor.
iii. Accrual of Addition to the Tax Under Section 6655, Interest Under 
Section 6601, and Penalties
    One commentator requests clarification regarding the accrual of the 
addition to the tax under section 6655, interest under section 6601, 
and penalties under the proposed regulations. Specifically, the 
commentator requests that the final regulations clarify whether a 
partnership's deemed payment of 1446 tax under proposed regulation 
Sec.  1.1446-3(e)(2) will stop the accrual of the addition to the tax, 
interest, and penalties that may be applicable under proposed 
regulation Sec.  1.1446-3(e)(3) or other sections of the regulations. 
The commentator requests that the final regulations address the accrual 
of the addition to the tax, interest and penalties, and explicitly 
provide that such additions, penalties and interest will stop accruing 
on the date the partnership's liability is deemed paid.
    The final regulations do not explicitly address the accrual of all 
of the potential penalties that may apply to a partnership required to 
pay 1446 tax, but do include provisions and examples that illustrate 
the application of sections 6655 (relating to the addition to the tax 
for an underpayment of an installment of 1446 tax), 6601 (relating to 
interest), and 6651 (relating to failure to file and failure to pay 
penalties).
    Regarding the addition to the tax under section 6655, the final 
regulations provide that the addition to the tax will begin to accrue 
on the date that the partnership underpays an installment of 1446 tax 
and will stop accruing on the earlier of the date when all the 1446 tax 
is satisfied, or the 15th day of the 4th month following the close of 
the partnership's taxable year (15th day of the 6th month in the case 
of a partnership keeping its books and records outside the United 
States and Puerto Rico).
    As discussed in part C.6.i. of this preamble, the final regulations 
provide that a partner's payment of tax that deems a partnership to 
have paid 1446 tax will not be credited to the partnership's account 
until the later of the date that the tax is considered to have been 
paid by the partner under section 6513(a) and (b)(2) (prescribing the 
date tax is considered paid for purposes of sections 6511(b)(2), (c), 
and 6512), or the last date for paying 1446 tax without extensions 
(i.e., the unextended due date for Form 8804). Under this ``later of'' 
rule, the earliest that a partner's payments can be credited to the 
partnership is the last date for paying the 1446 tax without extensions 
(the unextended due date for Form 8804), the date that the accrual of 
the section 6655 addition to the tax would stop in any event. As a 
result, a partner's payments of estimated tax will not provide a 
partnership with any benefit with respect to the partnership's 
computation of the underpayment addition to the tax under section 6655, 
as applied in the regulations.
    Regarding interest under section 6601, if a partnership's 1446 
liability has not been satisfied, or deemed satisfied, by the last date 
prescribed for payment of the 1446 tax under section 1461 without 
extensions (see section 6601(b)(1)), then interest under section 6601 
will begin to accrue on the unpaid 1446 tax liability. The final 
regulations provide that interest will stop accruing on the date and to 
the extent that the partnership actually pays the 1446 tax or is deemed 
to have paid the 1446 tax under the deemed payment rule in the 
regulations.
    Section 6651(a)(1) generally applies to the failure to file any tax 
return by the due date (including extensions) prescribed therefore and 
applies in the context of section 1446 to a failure to file Form 8804. 
The penalty accrues at 5 percent of the amount of the tax that is 
required to be shown on the return for each month or fraction of a 
month during which the required return is not filed but not exceeding, 
in the aggregate, 25 percent of the amount required to be shown as tax 
on the return. Similarly, under section 6651(a)(2), for each month 
after the date prescribed for payment that a taxpayer fails to pay the 
amount shown as tax on any return, there is added to the amount shown 
as tax 0.5 percent of such tax not to exceed 25 percent in the 
aggregate. While section 6651(a)(1) applies upon a failure to file a 
return, and section 6651(a)(2) only applies if a return has been filed, 
there are circumstances where both penalties can apply. See 6651(c). 
Both penalties provide an exception if it is shown that such failure is 
due to reasonable cause and not due to willful neglect.
    Under the deemed payment rule of the final regulations, discussed 
above, a partnership that fails to pay 1446 tax with respect to a 
foreign partner will be deemed to have paid the 1446 tax associated 
with the ECTI allocable to such foreign partner on the later of the 
date that such partner is considered to have paid its U.S. income tax 
under section 6513(a) and (b)(2), or the last date for payment of the 
1446 tax without extensions. Section 6651(b)(1) reduces the base upon 
which the section 6651(a)(1) penalty is computed (the amount required 
to be shown as tax on the return) by the partnership's actual and 
deemed payment of tax, provided the actual or deemed payment occurs on 
or before the date prescribed for payment of the tax. To the extent the 
partnership has not paid (or been deemed to have paid) all 1446 tax due 
with respect to a partner as of the date prescribed for payment of the 
tax, the failure to file penalty under section 6651(a)(1) will begin to 
accrue on the Form 8804 filing due date and will continue to accrue 
until the earlier of the date that Form 8804 is actually filed, or the 
date that the maximum monthly accrual has occurred under the section; 
i.e., five months. Stated differently, if a partnership fails to file 
Form 8804 and the 1446 tax has not been paid or deemed paid by the date 
prescribed for payment of the tax, the failure to file penalty will 
begin to accrue and may only be stopped by the partnership filing such 
form or the statutory limit of the penalty being reached; payment of 
the 1446 tax (actual or deemed) after the date prescribed for payment 
of the tax, without actually filing Form 8804, will not stop the 
accrual of the penalty.
    A similar analysis applies to the accrual of the failure to pay 
penalty under section 6651(a)(2). However, the failure to pay penalty 
cannot be imposed unless Form 8804 is filed and the accrual of the 
penalty can be stopped by paying the 1446 tax. Once Form 8804 is filed, 
the penalty accrues at a rate of 0.5 percent of the amount of the 
unpaid 1446 tax beginning on the

[[Page 28710]]

due date for payment of such tax (with regard to extensions), 
regardless of when the form was filed, and continues to accrue each 
month on the unpaid 1446 tax until the earlier of the date the 1446 tax 
is completely paid, deemed paid, or the maximum monthly accrual of 25 
percent in the aggregate is reached. The time at which a partnership is 
deemed to have paid 1446 tax for purposes of sections 1446, 1461, 1463, 
6601, 6651, and 6655 is discussed above.
7. Application of De-Minimis Rule of Section 6655(f)
    The proposed regulations state that the principles of section 6655 
shall apply to a partnership computing its 1446 tax. Section 6655(f) 
provides that a corporation is not required to pay estimated tax when 
the amount of such tax is less than $500. However, the proposed 
regulations under section 1446 do not address the application of the 
principles of section 6655(f) in the context of section 1446.
    One commentator proposes that a partnership with more than 100 
nonresident alien partners should not be required to pay 1446 tax (or 
any installment of such tax) on behalf of a nonresident alien partner 
if the estimated ECTI allocable to the nonresident alien partner does 
not exceed the annual personal exemption provided to such partner under 
section 151 of the Internal Revenue Code. The commentator states that 
the administrative costs associated with the payment of 1446 tax for 
such partners is burdensome when considered in light of the fact that 
these foreign partners are often entitled to refunds of such amounts. 
Further, the commentator suggests that these nonresident alien 
partners, who otherwise have no presence in the United States, often 
have difficulty in securing refunds and, as a result, are discouraged 
from seeking such refunds because of the small dollar amounts involved.
    The final regulations describe the application of the principles of 
section 6655(f) for purposes of section 1446. The final regulations 
provide that a partnership shall apply the principles of section 
6655(f) by taking into account all foreign partners. That is, the 
partnership must compare its total 1446 tax liability for all foreign 
partners to the $500 threshold in section 6655(f). However, Treasury 
and the IRS believe that the section 1446 regime should operate so that 
it does not discourage investment in the United States by imposing 
administrative costs on partnerships that are unrelated to insuring 
that the appropriate amount of tax is collected. Consequently, the 
temporary regulations contain an exception to this rule that applies in 
certain circumstances. See part G.9. of this preamble, below.
8. Application of Section 6655(i)
    The proposed regulations under section 1446 state that the 
principles of section 6655 shall apply to a partnership required to pay 
1446 tax. Section 6655(i)(2) provides that section 6655 shall apply to 
taxable years of less than 12 months in accordance with regulations 
prescribed by the Secretary. However, the proposed regulations under 
section 1446 do not address the application of the principles of 
section 6655(i)(2).
    The final regulations provide that even if a partnership has a 
taxable year of less than 12 months, the partnership is required to pay 
1446 tax (including installments of such tax) if the partnership has 
ECTI allocable to foreign partners. In such a case, the partnership 
shall adjust its installment payments of 1446 tax in a reasonable 
manner (e.g., the annualized amounts of ECTI estimated to be allocable 
to a foreign partner, and the percentage of tax to be paid with each 
installment) to account for the short taxable year. However, if the 
partnership's taxable year is a period of less than four months, the 
partnership shall only be required to file Form 8804 in accordance with 
the regu