As globalization accelerates cross-border capital flows, foreign investors increasingly seek access to U.S. markets through investment vehicles such as Limited Partnerships (LPs). Many of our clients have asked about friends or family members who are non-US taxpayers investing in their AMLP. While LPs offer attractive flexibility and pass-through taxation, participation by non-U.S. persons triggers a range of U.S. tax withholding, reporting, and regulatory obligations. This article outlines the key considerations for structuring and managing foreign investment in U.S. LPs.
1. Withholding Tax on U.S.-Source Income
A. FDAP Income Withholding (IRC §§1441–1442)
When a U.S. LP allocates U.S.-source passive income—such as dividends, interest, rents, or royalties—to a foreign partner, the LP is generally required to withhold 30% of that income, unless reduced by an applicable income tax treaty. These rules apply even if the foreign partner is investing through a passive holding interest.
B. Effectively Connected Income (ECI) and IRC §1446 Withholding
If the LP is engaged in a U.S. trade or business (including activities like operating real estate, managing a U.S.-based company, or active rental operations), the share of income allocable to a foreign partner is considered Effectively Connected Income (ECI). The LP must:
- Withhold 37% for individual partners and 21% for corporate partners,
- File Form 8804 and 8805 annually, and
- Issue Schedule K-1 to the foreign partner reflecting ECI allocations.
Failure to properly withhold can result in personal liability for the partnership and potential penalties.
2. FIRPTA: Real Estate Investment Considerations
Under the Foreign Investment in Real Property Tax Act (FIRPTA), gains derived by a foreign partner from the sale of U.S. real property (directly or indirectly through an LP) are treated as ECI. Consequently:
- A 15% withholding on gross sale proceeds is required,
- The LP must report via Form 8288 and 8288-A, and
- The foreign partner must file a U.S. tax return to report the gain.
Note that foreign individuals investing in U.S. real estate through an LP may also face estate tax exposure on the value of their U.S. holdings.
3. FATCA and Information Disclosure
The Foreign Account Tax Compliance Act (FATCA) requires U.S. entities making payments to foreign partners to document their tax status using IRS Forms W-8BEN or W-8BEN-E. While most domestic LPs are not financial institutions subject to FATCA themselves, they often act as withholding agents and are responsible for compliance. In some cases, LPs with foreign intermediaries may need to file Form 8966 to disclose U.S. owner information to the IRS.
4. Filing and Identification Requirements
Foreign partners with U.S.-source income or ECI must:
- Obtain a U.S. Taxpayer Identification Number (TIN or ITIN),
- File Form 1040-NR (individuals) or 1120-F (foreign corporations) to report U.S. income, and
- May be eligible to recover over-withheld tax through refund claims.
The LP itself must issue K-1s and 8805 forms annually to all partners, including non-residents.
5. Corporate Transparency Act (CTA) & Beneficial Ownership
As of 2024, U.S. LPs are subject to the Corporate Transparency Act, which mandates the reporting of beneficial owners to FinCEN. This includes foreign individuals who either:
- Own 25% or more of the LP, or
- Exercise substantial control over its operations.
Reporting exemptions are limited, and penalties for noncompliance are significant.
6. Securities and Investment Regulation
LPs that pool investor funds for joint enterprise may fall under the definition of an investment company, subject to regulation under the Investment Company Act of 1940. However, most private funds avoid registration by relying on exemptions under Regulation D (Rule 506) and Regulation S (offshore offerings). Careful structuring is necessary to ensure:
- Proper exemption from SEC registration,
- Accurate investor accreditation,
- Compliance with offering rules for foreign nationals.
7. CFIUS: Foreign Control of Sensitive U.S. Businesses
The Committee on Foreign Investment in the United States (CFIUS) has the authority to review and potentially block foreign investments in U.S. businesses that may impact national security. Investments in sectors such as technology, critical infrastructure, or real estate near sensitive locations may require voluntary or mandatory filings. LPs with foreign investors should evaluate whether CFIUS jurisdiction may be triggered by proposed investments.
8. Estate and Gift Tax Exposure
Foreign individuals investing directly in U.S. real estate or tangible property via an LP are exposed to U.S. estate and gift taxes on death or transfer. The estate tax exemption is limited to $60,000 (absent treaty relief), exposing significant assets to potential 40% taxation. A common solution is to hold the LP interest through a foreign corporation ("blocker"), which itself is not considered U.S.-situs property.
Structuring Recommendations for Foreign Investors
To mitigate exposure and streamline compliance, consider the following strategies:
| Strategy | Purpose |
|---|---|
| Use a U.S. Blocker Corporation | Avoid ECI and simplify tax filing for foreign investors |
| Foreign Parent Entity | Reduce estate tax exposure by making the LP interest non-U.S. situs |
| Tiered LP/LLC Structure | Separate operations, protect liability, and isolate ownership |
| Advance Treaty Analysis | Reduce withholding rates under applicable tax treaties |
| CFIUS Review Planning | Avoid surprise reviews in sensitive industries |
| Legal Opinion and Compliance Checklists | Ensure full compliance with FATCA, CTA, and SEC rules |
Work Around Options
There are ways in which this can be simplified which would be for the Non-US person to create a US LLC, which in turn would then be the investor in the LP. The other option would be for the Non-US person to loan money to the LP. Both of these options have there own considerations and need to be fully researched before proceeding.
Final Thoughts
Foreign participation in U.S. LPs remains an attractive vehicle for cross-border investment, but only with full awareness of the U.S. tax and legal landscape. Proper structuring at the outset—together with ongoing compliance—can preserve the benefits of pass-through treatment while minimizing exposure to tax, penalties, and enforcement risk.
Attorneys, CPAs, and fund sponsors working with foreign investors should regularly update their understanding of U.S. compliance developments to provide sound guidance in this evolving arena.
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