By David Duner, CPA and Del Facundo, CPA
November 30, 2016

This article is meant to describe the IRS filing and tax withholding requirements regarding the payment of income distributions of a mortgage pool limited liability company to a nonresident alien member.

There are several forms and withholding tax considerations to be aware of.

The managing member of the LLC is generally required to withhold taxes on income distributions paid to a nonresident alien.
The managing member first needs to determine if the foreign investor is a nonresident alien or a resident alien.

A resident alien is an individual that has been physically present in the United States for no less than 31 days in the current year and has been physically present in the United States for no less than 183 days over a three-year period, including the current year and the two preceding years. Therefore, he or she would pass the substantial presence test and would be classified as a resident alien. A resident alien can also be an individual that has a Green Card permit that allows the individual to legally live and work in the United States on a permanent basis.

A resident alien is generally subject to tax in the same manner as a U.S. citizen. A resident alien who is not a green card holder must have a taxpayer identification number from the Internal Revenue Service. A resident alien who is a green card holder must have a social security number. The managing member will treat a resident alien the same as a U.S. citizen and will simply issue an IRS form K-1 to the individual indicating his or her share of the distributive income of the LLC for the taxable year and no tax withholding requirements are necessary.

A nonresident alien is an individual who is a non-U.S. citizen, and does not pass the green card test or the substantial presence test for a calendar year.
A nonresident alien is subject to U.S. income tax only on U.S. source income. A nonresident alien member of an LLC will also be issued IRS form K-1 indicating his or her share of the distributive income of the LLC for the taxable year.

The LLC manager must first obtain IRS form W-9, Request for Taxpayer Identification Number and Certification, from the individual. This form will provide the manager with either the social security number or the taxpayer identification number. The individual needs to use IRS Form W-7 (Application for IRS Individual Taxpayer ID number) to obtain these identification numbers.

To a nonresident alien, income coming from a mortgage pool LLC operating in the U.S. is considered “effectively connected income” to a U.S. trade or business. Therefore, when the foreign investor files his or her U.S. income tax return (IRS form 1040NR), the income is subject to our common graduated income tax brackets and allocated expenses are allowable. Since the allocated distributive income is considered “effectively connected income” it is subject to withholding tax at the highest U.S. income tax rate which is 39.6% or a lower tax rate depending on the type of income (i.e. the withholding tax rate on long-term capital income would be 20%). The withholding tax rate is applied to the member’s share of gross distributive income reduced by the nonresident member’s share of partnership deductions for the taxable year. Certain nondeductible expenses, such as a loan loss reserve should not be taken into consideration in determining the net distributive income subject to tax withholding.

The managing member must obtain from the nonresident alien IRS Form W-8ECI, Certificate of Foreign Persons Claim That Income is Effectively Connected With the Conduct of a Trade or Business in the United States. This form will provide the taxpayer identification number of the nonresident alien to the managing member. Form W-8ECI serves as a representation by the nonresident alien that the income received from the mortgage pool LLC is effectively connected with the conduct of a trade or business within the U.S. This form must be retained in your records and does not need to be submitted to the IRS.

If the foreign investor is a foreign flow through entity, such as a foreign partnership, then the managing member must obtain IRS form W-8IMY.
The burden is on the foreign investor to provide the necessary information to the managing member on the form W-8ECI or W-8IMY.

It is the responsibility of the managing member to withhold tax on each distribution payment made to a nonresident alien. Note that the calculation of the withholding tax is based on the allocated share of distributive net income, and the resulting tax withheld is subtracted from the income distribution payment.

IRS form 8804-C, Certificate of Partner-Level Items to Reduce Section 1446 Withholding –

A nonresident alien can submit IRS form 8804-C to the partnership. This form can be used by the foreign partner to reduce or eliminate the withholding tax on the partner’s allocable share of effectively connected income. The foreign partner uses this form to certify to the partnership that he or she has certain partner-level deductions and losses that can reduce or eliminate the withholding tax.

In addition, if this partnership is the foreign partner’s only investment giving rise to effectively connected income, IRS form 8804-C can be used to eliminate the withholding tax. Also if the partnership estimates that the annualized withholding tax due for a particular foreign partner is less than $1,000, IRS form 8804-C can be used to eliminate the withholding tax.

If a partnership that receives a form 8804-C from a foreign partner uses this certification to reduce or eliminate the withholding tax, it must submit a copy of the form to the IRS. A foreign partner must submit a new form 8804-C each year to the partnership.

How to Remit the Withholding Tax to the IRS:

The total amount of the tax withheld is paid quarterly using IRS form 8813, Partnership Withholding Tax Payment Voucher-Section 1446. The tax and form are due on or before April 15, June 15, September 15, and December 15 of the year.

The monthly payment remittance advice provided to the nonresident alien partner must contain the amount of the tax withheld from the payment and the year to date amount of tax withheld.

IRS Annual Tax Form Reporting Requirements:

IRS form 8804, Annual Return for Partnership Withholding Tax (Section 1446) –
IRS form 8804 is used to calculate and report the total tax liability on the effectively connected taxable income for the year. It also reconciles the total tax liability to the total deposits made for the year. This form must be mailed to the IRS by April 15th of the following year.

IRS form 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax –
IRS form 8805 is provided to the nonresident alien partner. This form reports the amount of the effectively connected taxable income and the total tax withheld that is allocable to the foreign partner for the year. A nonresident alien partner must attach IRS form 8805 to his or her U.S. income tax return (IRS form 1040NR) to claim a withholding credit for their share of the tax withheld by the partnership. The nonresident alien partner must receive their copy of this form by April 15th of the following year.

This article is meant for information purposes only. The specific rules related to the above subject are more in depth. Please consult your tax advisor for additional information and specific requirements.

David Duner, CPA is the managing partner and founder of David Allen Duner, Certified Public Accountants, Irvine, CA.  Del Facundo, CPA is a tax manager.  Our firm has been providing audit and tax services to the mortgage industry for over 25 years.  We can be reached at (949) 263-0030 or at David@DunerCPA.com or Del@DunerCPA.com