US Subsidiaries: Beware of Surprise Tax

Nina Wang

Capital gains made from the sale of personal property are generally associated with the residency of the person making the sale. This means that if a foreign person has a capital gain from the sale of personal property, the capital gain is generally sourced to the foreign residence of the person and not subject to U.S. tax. However, withholding tax would be required if the sale involves U.S. company stock that is part of the U.S. Real Property Holding Corporation (USRPHC). Foreign investors will need to understand the status of their U.S. stock to predict their tax responsibilities when making deals to avoid any surprises on their tax bills.  

U.S. Real Property Holding Corporation (USRPHC)

U.S. real property interests (USRPIs) include shares or other equity interests in a U.S. corporation that were considered to be a USRPHC at any time during the shorter of the taxpayer’s holding period for the interest or the five-year period ending on the date of the disposition of such interest. A domestic corporation is typically considered to be a USRPHC when the fair market value of its U.S. real property interests equals or exceeds 50% of the fair market value of total assets used or held for use in its trade or business.  

Real property includes land, real property improvements such as building structures on top of that land, leasehold interests, and products that come from the land such as crops, wood, mined goods, well water, or other natural deposits. It also includes other property that is considered connected to the use of that land such as mining equipment, tractors, drill rigs, or other equipment to work the land. 

The Foreign Investment in Real Property Tax Act (FIRPTA) 

The disposition of a U.S. real property interest (including the sale of U.S. Stock of a USRPHC) by a foreign person is subject to the Foreign Investment in Real Property Tax Act (FIRPTA) of 1980. Under FIRPTA, the disposition of a USRPI by an international investor requires the purchaser to withhold 15% of the gross sale price regardless of the actual amount of tax due on the gain.   

Amounts withheld by the purchaser must be reported and paid to the IRS on Forms 8288 and 8288-A within 20 days of the transfer. Failing to withhold the correct amount can leave the purchaser liable for the entire amount of the tax with added penalties plus interest. 

Withholding Tax Exceptions 

There are exceptions to those withholding requirements such as obtaining a withholding certificate from the IRS to reduce or remove the withholding amount or when the stock is publicly traded. There are also no withholding requirements for a USRPI acquired for residential purposes as long as the amount is below $300,000. Other withholding exemptions include acquiring an affidavit confirming a nonforeign status, stating the transfer is a nonrecognition event, or that it is not a USRPI. The traces of USRPI status can be erased if the business disposes of all its USRPIs in a taxable transaction ahead of the disposition of its stock. This option requires the company to notify the IRS regarding the early termination of the USRPHC status. If this occurs, there would be no withholding tax requirement when foreign shareholders relinquish ownership of the corporation.   

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