If your partnership has foreign Limited Partners (LPs), U.S. Treasury Regulations require the partnership to withhold and remit certain taxes to the IRS. The type of income the partnership earns determines how withholding applies:
- Effectively Connected Income (ECI) – income from a U.S. trade or business (e.g., staking, operations).
- Fixed, Determinable, Annual, or Periodical (FDAP) Income – passive income from U.S. sources (e.g., dividends, interest, royalties).
What is Effectively Connected Income (ECI)?
ECI is income that is treated as connected with a U.S. trade or business. Partnerships must withhold and remit U.S. tax at the entity level on FDAP allocated to foreign LPs.
- Withholding is done by the partnership, not by individual LPs.
- The partnership issues Form 8805 to foreign LPs, reporting their share of gross ECI and the amounts withheld.
Example: If the partnership earns staking income from a crypto protocol, this may create ECI subject to partnership-level withholding.
What is FDAP Income?
FDAP includes passive U.S.-source income like interest, dividends, and royalties. Partnerships must withhold and remit U.S. tax at the entity level on FDAP allocated to foreign LPs.
- Withholding is done by the partnership, not by individual LPs.
- The partnership issues Form 1042-S to foreign LPs, reporting their share of gross FDAP income and the amounts withheld.
Example: If the partnership earns U.S.-source dividends through a money market account, withholding applies for foreign LPs.
How are payments made?
- If fund cash is available: The partnership makes the tax payment directly.
- If no cash is available:
- A manager or other party wires funds into the partnership account to cover the payment (which can be reimbursed from future distributions).
- Less commonly, the partnership initiates a capital call to the impacted LPs (time-consuming and not recommended).
Is this included in setup or admin fees?
No. These tax obligations are contingent on the fund’s activities (e.g., earning ECI or FDAP) and vary by year. They are not included in initial setup fees or standard administration costs.
What does this mean for LPs?
- Foreign LPs: Withholding at the partnership level generally satisfies their U.S. tax obligation on that income. They will receive a Form 8805 or 1042-S for their own reporting.
- U.S. LPs: They are taxed directly on their allocations of income but do not have tax withheld at the partnership level.