Tax Court Rejects IRS Attempt to Tax Non-U.S. Investor on Sale of Partnership Interest

In a recent case, the U.S. Tax Court rejected the IRS’s longstanding and controversial position adopted in a 1991 ruling. In the 1991 ruling, the IRS took the position that a non-U.S. partner’s gain on the sale of an interest in a partnership is treated as income effectively connected with a U.S. trade or business (“ECI”) to the extent such gain is attributable to the partnership’s assets held for use in the partnership’s U.S. trade or business. Contrary to the IRS’s position in the ruling, the tax court held that a non-U.S. corporate taxpayer was not subject to U.S. federal income tax on the gain realized from the redemption of the taxpayer’s interest in a U.S. operating LLC taxed as a partnership. The tax court’s decision, if sustained on appeal, may have structuring implications for a non-U.S. investor’s investment in a partnership engaged in a U.S. trade or business.

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