The IRS has stepped up efforts to increase taxpayer compliance with foreign information reporting. It is now common practice for IRS auditors to ask for copies of the taxpayer’s information filings during the course of an audit.
In general, taxpayers are required to withhold 30% federal tax on certain payments made to foreign persons. The income subject to withholding is a type that is fixed, determinable, annual, or periodic, referred to as “FDAP” income. This type of income is generally interest, dividends, rents, and royalties. In addition, withholding is required for services performed in the US. The 30% withholding requirement can be reduced or eliminated by taking advantage of the US income tax treaty benefits. However, even if a US income tax treaty eliminates the withholding requirement, the payment is still required to be reported using the Form 1042 series. These forms are due March 15 and can be extended. In order to claim treaty benefits, the US payor must have a valid form W-8BEN on file. This form can be obtained on the IRS website at http://www.irs.gov/pub/irs-pdf/fw8ben.pdf. Except in limited circumstances, in order to take advantage of reduced treaty rates of withholding, the payee will need to obtain a US tax identification number to properly complete form W-8BEN. Form W-8BEN should be obtained before any payment is made to the foreign party. As the withholding agent, the US payor of the income subject to these rules will be responsible for the 30% withholding if they do not have a valid W-8BEN on file.
A foreign individual can obtain an Individual Taxpayer Identification Number (ITIN) by filing form W-7. Please note this type of identification number is not for individuals who have the appropriate authorization to work in the US. A foreign corporation uses form SS-4, Application for Employer Identification Number to obtain a taxpayer identification number.
If the payments being made to a foreign-related party exceed $500,000 and a US income tax treaty provision is being used to reduce or eliminate withholding, the form W-8BEN will ask that the foreign related party indicate their agreement to file form 8833, Treaty-Based Return Position Disclosure. Foreign related parties should be made aware of this requirement.
If a payment is being made to a non-resident for services being performed in the US, the payor would be required to obtain form 8233, Exemption from Withholding on Compensation for Independent (and Certain Dependent) Personal Services of a Nonresident Alien Individual to avoid withholding. This form should be obtained before any payment is made to the foreign party and must be submitted to the IRS within 5 days of acceptance.