A partnership is a pass through entity for tax purposes, meaning that profits/losses are channeled directly to the partners and they are the ones to be taxed. Thus partnerships avoid the double taxation (corporate tax + dividend tax) typical of corporations, yet still maintain the limited liability principle typical of corporations. Partnerships do not owe taxes on the partnership level, but must still file an informative report of its business activity. As part of the report, the partnership provides all of its investors with a 1-K form for their personal tax reports. The 1-K contains information of profits/losses according to each partner’s relative share.
The report is to be filed annually by March 15 of the consecutive year. An extension until September 15 can be received. Partnerships managing their books outside the US may file until June 15. Most US states are synched with the IRS and require filing as well.
Please note! An LLC with two or more investors is automatically labeled as a partnership. Most US states align with the IRS categorization and view LLCs as partnerships.
Partnership with alien citizens
Partnerships with ECI income such as activities on Amazon, income from rent, etc., must deduct tax at source for all of its alien partners. According to section 1446, the partnership must deduct tax at the highest rates of the tax code – 37.5% for yielding income and 20% for capital income. Prior to filing, the partnership must provide its partners, in addition to the 1-K, form 8805 which testifies to the deduction at source. The investor will receive the paid taxes as credit when filing, and will often also receive a refund.
Partnerships with FDAP income must deduct at source per section 1445, according to the treaty rates or the 30% determined by the law. The partnership will provide the investor with form S-1042.
For many years there was uncertainty concerning selling a share of a partnership by an alien citizen. Theory provided two contradicting perceptions: one claiming that a partnership is a separate entity from its owners and as such, the sale should be exempt from tax – just like when selling stocks. The second considers the partner to be the relative owner of each and every one of the partnership’s assets, obligating in some cases at deduction at source. A solution was reached after a significant verdict in the Grecian Magnesite Mining v. Commissioner case. Consequently, the IRS determined that the second perspective is the deciding one – each asset should be examined to find out if it should be taxed for foreigners. The IRS also determined a 10% deduction at source for the portion affiliated with the ECI.
Holding style comparison
| Individual | LLC | LP | House company |
Taxation in the US | Choice between ECI and FDAP FDAP – 30% of gross (for rental only) ECI – individual income tax brackets. Capital gain – range of over one year according to preferential tax brackets. | Choice between ECI and FDAP FDAP – 30% of gross (for rental only) ECI – individual income tax brackets. Capital gain – range of over one year according to preferential tax brackets. | Choice between ECI and FDAP FDAP – 30% of gross (for rental only) ECI – individual income tax brackets. Capital gain – range of over one year according to preferential tax brackets. | Choice between ECI and FDAP FDAP – 30% of gross (for rental only) ECI – individual income tax brackets. Capital gain – range of over one year according to preferential tax brackets. |
Taxation in Israel | Choice between ECI and FDAP | Marginal tax if not fully disclosed | Choice between ECI and FDAP | Choice between ECI and FDAP |
Legal protection | Nonexistent | Limited liability and separation of entities | Limited liability and separation of entitiesonly for limited partners, no legal protection for the general partner | Limited liability and separation of entities |
Exposure to national insurance (Bituach Leumi) | Only in the marginal track | No exposure | Only in the marginal track | According to section 373A of the social security code *Decided in court
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Exposure to FIRPTA | Yes | Yes for an individual, no for a partnership. Ongoing prepayments for a partnership. | No. Ongoing prepayments for a partnership. | Yes for an individual, Ongoing prepayments for a partnership. |
Exposure to inheritance tax | Yes | Yes | Yes | In the case of unknown disclosure. No exposure in the other case.
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Required to file in Israel | Depending on the Israeli tax track | Yes | Yes | Yes |
Foreign tax credit | Yes, in the marginal track | According to the income tax circular 5/2004, tax classification between Israel and the US is significant for calculating income basket | Yes, in the marginal track | Yes, in the marginal track |
Loss offset | According to the income tax ordinance | Losses cannot be offset against profits not generated by the same LLC. Offset within the LLC according to the income tax ordinance. | According to the income tax ordinance | According to the income tax ordinance |
Identification numbers | ITIN only | EIN and ITIN required | EIN and ITIN required | EIN and ITIN required. Additionally, in order for the tax classification to be identical, it is mandatory to check the box in the US. |
