Payments of US Source Income to Foreign Parties: Withholding & Reporting
This time of year businesses are busy preparing year-end information returns, including W-2s and 1099s. Often overlooked are the rules regarding withholding and information reporting related to payments made to foreign persons. The information below is a reminder of the 1042 filing requirements related to payments of certain US source income to foreign persons.
Payments of US Source Income to Foreign Persons
Foreign persons are subject to US tax at a 30% rate on income they receive from US sources that consists of:
- Interest (including certain original issue discount (OID))
- Compensation for, or in expectation of, services performed
- Substitute payments in a securities lending transaction
- Other fixed or determinable annual or periodical gains, profits, or income
This tax is imposed on the gross amount paid and is generally collected by withholding under IRC §1441 or 1442 on that amount. A payment is considered to have been made whether directly to the beneficial owner or to another person, such as an intermediary, agent, or partnership, for the benefit of the beneficial owner.
The tax is generally withheld (chapter 3 withholding) from the payment made to the foreign person. A withholding agent is a US or foreign person, in whatever capacity acting, with control, receipt, custody, disposal, or payment of an amount subject to chapter 3 withholding. A withholding agent may be an individual, corporation, partnership, trust, association, or any other entity, including any foreign intermediary, foreign partnership, or US branch of certain foreign banks and insurance companies. Withholding agents are personally liable for any tax required to be withheld. This liability is independent of the tax liability of the foreign person to whom the payment is made. If an employer fails to withhold, and the foreign payee fails to satisfy its US tax liability, then both are liable for tax, as well as interest and applicable penalties. The tax will be collected only once. If the foreign person satisfies its US tax liability, employers are not liable for the tax but remain liable for any interest and penalties for failure to withhold.
Withholdable Payment & Rate
Generally, a withholdable payment is a payment of US source fixed or determinable annual or period (FDAP) income such as dividends, interest, royalties, and certain payments for personal services and, beginning in 2019, gross proceeds from the sale or other disposition of property of a type that can produce interest or dividends that are US source FDAP income. Withholding on FDAP income is generally at a statutory rate of 30%; however, if the payee is a resident of a country that has a tax treaty with the United States, the rate may be reduced. Payors should procure a form W-8BEN (individuals) or W-BEN-E (entities) from the payee to certify that the payee is a resident of a country and is claiming a reduced treaty rate. Taxes withheld must be remitted to the IRS via electronic funds transfer (EFTPS) on a timely basis. Specific guidelines vary based on the frequency and amount of withholding.
Payors of FDAP to foreign payees are required to prepare Form 1042-S and Form 1042-T and provide the information to each payee and the Internal Revenue Service no later than March 15 of the year following the payment. In addition, the payor must complete Form 1042, which is a reconciliation of the withholding taxes due and paid for the year. Form 1042 is also due no later than March 15. These forms are required even if no tax is required to be withheld under a treaty.
If you need assistance in determining your withholding and/or reporting responsibilities, contact Clayton & McKervey.