Article written by:
Mary McVicar, CPA
Your business is most likely very much in tune with the informational reporting required to report and file Forms 1099 with the IRS each year. But, 1099 reporting is only for recipients who are U.S. citizens, nationals or resident aliens. What happens if your company makes a payment to a foreign person? Similar to Form 1099, Form 1042-S is provided to a foreign person to report fixed or determinable, annual or periodic (FDAP) income or certain gains from dispositions of property. In addition to the 1042-S, Form 1042-T is used to transmit a 1042-S filing(s) to the IRS and the Form 1042 is the annual return summarizing all 1042-S filings and the withholdings, which have been remitted for the year. FDAP income can include many sources of income but does not include income from the sale of property and does not include nontaxable income (such as tax-exempt interest income). Common examples of FDAP income include, but are not limited to: compensation for personal services, dividends, pensions and annuities, alimony sales commissions. Please consider the following for your 1042 reporting:
Key Things to Remember with 1042 reporting:
- Who is the recipient? A foreign person is not restricted to individuals. Reporting is required for payments to all foreign persons which include nonresident alien individuals, foreign corporations, foreign partnerships, foreign trusts, foreign estates and the catch-all: any other person that is not a U.S. person.
- Do I have all of the necessary information needed from the recipient? For 1099 reporting purposes in the U.S., the payor requests a Form W-9 from the income recipient which provides the tax information details of the recipient. For 1042 reporting purposes, the payor should request a completed Form W-8BEN for a nonresident individual or a Form W-8BEN-E for any foreign person who is not an individual. These forms provide pertinent information about the income recipient as well as tax treaty benefits information which may reduce or exempt withholding from the income payments.
- Do I have a withholding requirement? Absent a treaty reduction, the standard withholding percentage on FDAP and with holdable payments to foreign persons is 30%. Review of the treaty between the U.S. payor and the nonresident recipient will confirm the actual withholding required, if any.
- Even if I do not have a withholding requirement for a recipient, do I still need to file? Yes. The IRS requires reporting even if after a treaty reduction, the withholding is completely eliminated.
- What about services performed by an individual outside of the U.S. for my U.S. company? When considering withholding, it’s necessary to consider the source. Services performed by an individual are sourced based on where the services are performed. If an individual is performing services outside of the U.S. for a U.S. business, the IRS’ position is that informational reporting is not required. If 1042s are prepared, this should be disclosed as income from non-U.S. sources. It is prudent to maintain documentation that designates where the services are performed and maintain the proper W-8 series documentation on file from the contractor.
- When are the filings due? The 1042, 1042-S and 1042-T are due on March 15th of the year following the calendar year in which the income was paid. There are no provisions for filing a fiscal year form.
- How do I withhold? While the 1042 reports the withholding throughout the year, the amount of withholding tax due and the date of income payment dictate when the withholding is due. Withholding may be due as soon as 3 days after the payment or as late as March 15th of the following year (at the time of the 1042 filing). All payments should be remitted electronically, generally through EFTPS.
What are some of the important changes affecting 1042 reporting this year?
- New – Box 13j – Limitation on benefits code. This requires withholding agents who are withholding at a reduced treaty rate – to include a code for the recipient. Provisions for limitations on benefits are offered in the applicable treaty and contain criteria/tests that must be met in order for a recipient to receive a reduced withholding rate.
- New – Boxes 16d and e. Chapter 3 and 4 status code for a payer is now required if an authorized agent is acting as a withholding agent for the payer.
- U.S. financial institutions are no longer permitted to report the same type of income paid to the same beneficial owner who holds multiple accounts on one 1042-S. Account-by-account reporting is now required.
- With all of the changes beginning in 2017 with tax return due dates, it is important to note there is no change for 1042 reporting deadlines.