International Tax Withholding | Chapter 3 of the Internal Revenue Code

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TL Fahring focuses on helping individuals and businesses with a wide variety of matters involving state, federal, and international taxation. He has represented clients in all stages of federal and state tax disputes, including audits, administrative appeals, litigation, and collection matters. Mr. Fahring also has used his tax knowledge to assist clients in planning complex domestic and international transactions, including advising as to potential reporting and withholding requirements.

Mr. Fahring received his J.D. from the University of Texas School of Law, where he graduated with high honors and was inducted into the Order of the Coif and Chancellors honors societies. After clerking for a year at the Texas Eleventh Court of Appeals, he attended New York University School of Law, where he received an LL.M. (Master of Laws) in Taxation and served as a student editor on the Tax Law Review.

One of the more confusing areas of international tax law is determining when withholding is required. Getting it wrong can have dire consequences.

Currently, U.S. international withholding provisions can be found in Chapters 3 and 4 of the Internal Revenue Code.  Chapter 3 contains the withholding provisions that are intended to approximate a foreign person’s U.S. federal income tax liability. Chapter 4, on the other hand, deals with withholding provisions put in place by the Foreign Accounts Tax Compliance Act of 2010 and is primarily aimed at obtaining information regarding account holders of foreign financial institutions and owners of certain foreign entities.

In this post, we’ll focus on Chapter 3 withholding, setting aside Chapter 4 for another time.

But first . . .

Why International Tax Withholding?

Legally, the reason for international tax withholding can be blamed mainly on a common law doctrine known as the revenue rule.

Put most simply, the revenue rule provides that a country may refuse to apply or enforce the tax laws or judgments of another country.[1]  This doctrine can, and on occasion has, been overridden by treaty.[2]  But, in the absence of a treaty, a country’s only recourse in collecting taxes on an item of income earned within its territory by foreign persons located outside of its territory is to collect the tax while that item is still within its territory or within the custody of its nationals.[3]

Hence, international tax withholding—a country’s way of snatching the money before it gets away.

Chapter 3 Withholding

Chapter 3 of the Internal Revenue Code contains three primary withholding regimes affecting foreign persons with U.S. source income: fixed or determinable annual or periodical income (“FDAP”) withholding, Foreign Investment in Real Property Tax Act (“FIRPTA”) withholding, and foreign partner withholding.

FDAP Withholding

In the United States, nonresident aliens and foreign corporations are subject to federal income tax on U.S. source income and certain items of foreign source income that are effectively connected with the conduct of a U.S. trade or business.[4]These persons owe tax at a flat rate of 30% on most types of income that aren’t effectively connected with the conduct of a U.S. trade or business.[5] On the other hand, such persons owe tax on income that is effectively connected with the conduct of a U.S. trade or business at the rates generally applicable to U.S. persons.[6]

And here’s where withholding comes in. Any person who is in receipt of most types of U.S. source FDAP income destined for a nonresident alien, foreign partnership, or foreign corporation must withhold and remit 30% of that item, unless this rate is reduced or eliminated by treaty.[7] FDAP income includes interest, dividends, rent, salaries, wages, premiums, annuities, compensations, remunerations, and emoluments.[8]

FIRPTA Withholding

Generally, gain or loss by a nonresident alien or foreign corporation from the disposition of a U.S. real property interest is treated as if it were effectively connected with the conduct of a U.S. trade or business.[9]

So, when a foreign person disposes of a U.S. real property interest, the transferee generally is required to deduct and withhold a tax equal to 15 percent of the amount realized on the disposition.[10]

A U.S. real property interest includes:

  1. any interest in real property located in the United States or the Virgin Islands (but not in any other U.S. territories or possessions for some reason), and
  2. any interest (other than as a creditor) in a domestic corporation, unless the transferor of the interest establishes that the corporation was not a U.S. real property holding corporation at any time in the preceding five-year period ending with the disposition of such interest.[11]

A U.S. real property holding corporation, in turn, is defined as any domestic corporation the fair market value of whose U.S. real property interests is at least 50% of the fair market value of its U.S. real property interests, its interest in non-U.S. real property, and any other assets held for use in its trade or business.[12]

Foreign Partner Withholding

A partnership is not taxed as such.[13] Instead, the partners of a partnership are liable for income tax on any income earned by the partnership.[14]

Partnerships are required to withhold tax if they have taxable income that’s effectively connected to the conduct of a U.S. trade or business that’s allocable to a foreign partner during the taxable year.[15] The amount required to be withheld is the portion of effectively connected taxable income allocable to the foreign partner during that year multiplied by the highest tax rate applicable to that partner.[16] Thus, for nonresident alien partners the rate of withholding would be 37%, and for foreign corporate partners the rate of withholding would be 21%.[17]  However, this rate may be reduced by treaty.

The sale of a partnership interest also may be subject to withholding if a nonresident alien or foreign corporation owns an interest in the partnership and the partnership is engaged in a U.S. trade or business.[18]  The amount required to be withheld would be 10% of the amount realized from the disposition of the partnership interest.[19]

What Happens if there’s no Withholding?

If a person is required to withhold on a payment to a foreign person under Chapter 3 but does not do so, that person may become liable for the tax that was required to be withheld.[20]  On the plus side, if a person does properly withhold, they’re indemnified against any claims and demands of any person for the amounts withheld.[21] So, at least that’s something.

Parting Thoughts?

This is just a brief taste of what U.S. international tax withholding—and specifically Chapter 3—has in store for you.  There are many ins and outs and many potential pitfalls. If you have any questions about international tax withholding, don’t hesitate to call us for a free consultation.


Freeman Law International Tax Symposium

Readers may be interested in the Freeman Law International Tax Symposium scheduled to take place virtually on October 20 and 21, 2022.  Attendees will qualify for CLE, CPE, and CE and the slate of presenters includes well-recognized speakers and panelists, such as the IRS Commissioner, a prior Chief Counsel of the IRS, a former Acting Assistant Attorney General of the U.S. Department of Justice Tax Division, and many others in government and private practice.

To Register for the Freeman Law International Tax Symposium, please visit




[1] Brenda Mallinak, The Revenue Rule: A Common Law Doctrine for the Twenty-First Century, 16 Duke J. Comp. & Int’l L. 79, 79 (2006). Although a common law doctrine stretching back to the eighteenth century, Mallinak cites Judge Learned Hand as being the first to provide a rationale for the revenue rule:

Even in the case of ordinary municipal liabilities, a court will not recognize those arising in a foreign state, if they run counter to the “settled public policy” of its own. Thus a scrutiny of the liability is necessarily always in reserve, and the possibility that it will be found not to accord with the policy of the domestic state. This is not a troublesome or delicate inquiry when the question arises between private persons, but it takes on quite another face when it concerns the relations between the foreign state and its own citizens or even those who may be temporarily within its borders. To pass upon the provisions for the public order of another state is, or at any rate should be, beyond the powers of a court; it involves the relations between the states themselves, with which courts are incompetent to deal, and which are [e]ntrusted to other authorities. It may commit the domestic state to a position which would seriously embarrass its neighbor. Revenue laws fall within the same reasoning; they affect a state in matters as vital to its existence as its criminal laws. No court ought to undertake an inquiry which it cannot prosecute without determining whether those laws are consonant with its own notions of what is proper.

Id. at 79, 86 (quoting Moore v. Mitchell, 30 F.2d 600, 604 (2d Cir. 1929) (Hand, J., concurring)). Thus, Hand sees the revenue rule as being rooted in concerns about diplomatic relations with other states—something outside of the purview of the courts.

Interestingly, the application of the revenue rule in Moore was used to prevent New York from enforce the tax laws of Indiana. Mallinak, supra at 85. The U.S. Supreme Court changed this result with Milwaukee County v. M. E. White Co., 296 U.S. 268, 268 (1935), in which the Court held that a tax judgment of a sister state was entitled to recognition under the Constitution’s Full Faith and Credit Clause. Mallinak, supra at 87-88.


[2] Id. at 95 (citing the U.S. tax treaties with Canada, Sweden, Denmark, and the Netherlands as having provisions allowing for cooperation regarding the enforcement of each nation’s tax laws).


[3] See Harvey P. Dale, Withholding Tax on Payments to Foreign Persons, 36 Tax L. Rev. 49, 50-52 (1980) (noting the existence of the revenue rule and various mechanisms of collecting tax from foreign persons quasi in rem (actions against the foreign person’s assets in the United States) or in personam (actions against a foreign person located in the United States), but acknowledging that the most important tool for collecting such taxes is withholding).


[4] See 26 U.S.C. §§ 871(a)(1), (b), 881, 882.


[5] See id. §§ 871(a), 881. For


[6] See id. §§ 871(b), 882.


[7] See id. §§ 1441(a), (b), 1442(a).  One theory about how the contours of FDAP income was delineated is that it only includes income with a where net income is roughly equal to gross income (in other word, not many associated deductions). Harvey P. Dale, Withholding on Payments to Foreign Persons, 36 Tax L. Rev. 49, 59 (1980) (citing Rev. Rul. 80-222 (in which the IRS guesses at Congress’s intent in defining FDAP)).


[8] See id. §§ 1441(b), 1442(a).


[9] 26 U.S.C. § 897(a).


[10] Id. § 1445(a).


[11] See id. §§ 897(c)(1), 1445(a).


[12] Id. § 897(c)(3).


[13] Id. § 701.


[14] Id.


[15] Id. § 1446(a).


[16] Id. § 1446(b)(1), (2).


[17] Id. §§ 1(j), 11(b).


[18] See id. §§ 864(c)(8), 1446(f).


[19] Id. § 1446(f).


[20] Id. § 1461.


[21] Id.