Reporting of Payments to Foreign Entities
Taxpayers have an obligation to file information reporting forms to report certain payments to nonresident individuals, foreign corporations, foreign partnerships, and certain foreign fiduciaries, estates, and trusts. In general, every U.S. person that makes a payment from U.S. sources must withhold the correct amount of U.S. withholding tax and remit that tax to the IRS. The withholding tax rate is 30% unless the rate is reduced by a tax treaty (discussed below) in force between the United States and the country in which the recipient of the income resides.
U.S. persons who make payments to foreign entities noted above are required to file Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, which is due by March 15 and is prepared on a calendar-year basis. An extension may be filed to extend the filing date, but not the payment of the tax. Taxpayers are also responsible for filing Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, and Form 1042-T, Annual Summary and Transmittal of Forms 1042-S. These are also due by March 15. It is important to note that Form 1042-S must be filed when a U.S. person makes payments to a foreign person who is subject to U.S. withholding, even if no tax was withheld because of an existing income tax treaty or specific statutory exemption from withholding as provided by the Code.
Types of Payments and Timing of Withholding
Payments include interest, dividends, rent, salaries, wages, premiums, annuities, compensation, remunerations, emoluments, or certain other fixed or determinable annual or periodic gains and income. The regulations provide guidance on the amount of tax to be withheld. The amount of withholding must generally be based on the gross amount of payments subject to withholding, with no allowance for deductions, and it is required at the time a payment is made to a foreign person for an amount that is subject to withholding as described above. Although similar requirements apply to dividend distributions, a more complex set of rules must be reviewed to ascertain if the corporate distribution represents a taxable dividend, a nontaxable return of capital, or a capital gain.
Exceptions from Withholding
Certain types of income payments made to foreign persons are exempt from withholding. These include most payments of income, other than compensation for personal services performed by an individual that is effectively connected with a U.S. trade or business, or payments of portfolio interest paid to foreign persons. Bank deposit interest that is not effectively connected with a U.S. trade or business is also exempt from withholding.
You are the withholding agent and are responsible for determining if a payee is a U.S. or foreign person. You should use a Withholding Certificate (the Form W-8 series, Form 8233, Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual, or Form W-9, Request for Taxpayer Identification Number and Certification) to ascertain the payee’s status. In certain situations, depending on the type of entity or the type of payment made, other forms may be required to be furnished to the Withholding Agent. These include Form W-8ECI, Certificate of Foreign Person’s Claim That Income Is Effectively Connected with the Conduct of a Trade or Business in the United States, or Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain U.S. Branches for United States Tax Withholding. If the Withholding Agent has actual knowledge that a U.S. person received the payment as an agent of a foreign person, the Withholding Agent must treat the payment as if it was made to the foreign person.
Many tax treaties provide for a lower rate of withholding, or zero withholding, on certain types of income, such as interest and dividends. A claim for a benefit under a tax treaty for a nonresident individual or a foreign corporation can be made on Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding, which includes the beneficial owner’s tax or employer identification number (TIN or EIN).
The rules governing the withholding of income tax with respect to payments to nonresident persons are complex. In order to comply with these rules and avoid related penalties, each payment must be carefully examined under the withholding regulations to determine if withholding and related information reporting applies. Contact us to ensure that you are in compliance with the withholding regulations.