Taxation & Estate Planning

IRS REMINDS TAXPAYERS OF A FIRPTA WITHHOLDING TRAP

By Charles Rubin

Internal Revenue Code Section 897 subjects foreign taxpayers to U.S. income tax on their gains from sales and dispositions of U.S. real property interests. Code Section 1445 imposes a 10% withholding tax, to be collected by purchasers, when a foreign taxpayer sells a U.S. real property interest. This tax is credited against the actual tax liability of the seller, with any excess withholding being refunded.

Because the purchaser must withhold the 10%, the purchaser must determine whether a seller of U.S. real property is a foreign taxpayer. Many purchasers will assume that if the seller is a U.S. entity, then there is no foreign seller and withholding is not required.

In Chief Counsel Advice 200836029, the IRS reminds taxpayers that if the seller of U.S. real property is a disregarded entity, and the owner of the disregarded entity is a foreign person, the purchaser is obligated to withhold on the transaction. How is a purchaser supposed to know if a selling entity is a disregarded entity, so as to determine if it is obligated to withhold?

One approved mechanism is to obtain a certification from the entity that it is not foreign and is not a disregarded entity. The Treasury Regulations provide suggested language for such a certification. If the entity is a disregarded entity, then additional certification will be needed to show that the owner is not a foreign person and is itself not a disregarded entity. If the appropriate certifications cannot be obtained, then the purchaser should withhold and pay over to the IRS the required 10% withholding.

For sure, many taxpayers (and their real estate counsel) believe that if the seller is a U.S. entity, they do not need to inquire further and do not have to withhold. To avoid being responsible for the withholding and potential interest and penalties out of their own pockets, taxpayers and their counsel should seek and obtain a nonforeign certificate (with the appropriate "nondisregarded entity" language) from all domestic entity sellers.

Presumably this applies even when the seller is a U.S. corporation, since such a seller can be a disregarded entity by reason of being a qualified Subchapter S subsidiary. In such case there is probably no withholding anyway because the parent S corporation would have to be domestic, but the certificate should still be sought because to get a valid domestic certification in this case, the certification needs to be issued by a non-disregarded parent owner of the disregarded Subchapter S affiliate instead of the disregarded affiliate itself.

Full post as published by Rubin on Tax on September 24, 2008 (boomark / email).