Foreign Tax-Exempt Organizations
Many foreign tax-exempt organizations have been providing services in the performing arts in the United States for decades. The U.S. payers have only recently begun informing the organizations that, absent a Code exception or treaty exemption, the payments for these performances are subject to 30 percent withholding tax. (In some cases there may be state tax withholding as well). The payer must report both the income and tax to the organization and the IRS on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. Payers must also submit a Form 1042 tax return reporting gross income, taxes withheld, and tax deposits.
In 2001, the IRS introduced procedures for foreign tax-exempt organizations to follow to obtain an exemption from the withholding tax. The procedures depend on whether or not the foreign organization is a resident of a country that has an income tax treaty with the United States.
In both cases, the foreign tax-exempt organization must record a U.S. employer identification number (EIN) on the form. Foreign organizations can apply for an EIN on Form SS-4, available on the IRS website at http://www.irs.gov/pub/irs-pdf/fss4.pdf. Entities with a foreign address cannot currently apply for an EIN online.
A foreign organization is not exempt from U.S. withholding tax based on its foreign tax-exempt status because many foreign countries have more liberal tax-exempt rules than the United States. However, a foreign organization that is tax exempt under section 501(c)(3) of the Internal Revenue Code (the “Code”) (or that would be exempt under that section if the organization applied for tax-exempt status) is not subject to a withholding tax on amounts that are consistent with such tax-exempt status.
A foreign organization claiming tax exemption under U.S. rules must provide the payer a Form W-8EXP prior to payment. The submitter of Form W-8EXP must check:
In addition, such a foreign tax-exempt entity must attach an affidavit stating that it is not a private foundation and so indicate in Box 12c or indicate that it is a private foundation in Box 12d. (The 4 percent excise tax on private foundations is not overridden by a tax treaty exemption because excise taxes are not covered by income tax treaties.)
U.S. income of a foreign tax-exempt organization making such a claim is reported under Recipient Code 07 and Exemption Code 02 on a Form 1042-S. No U.S. tax return is required.
If the organization’s income is unrelated business income under section 512 of the Code (and therefore not tax exempt) such income may be exempt from withholding if the income is effectively connected with the conduct of a trade or business in the United States. For exemption from the withholding tax as effectively connected income, the organization must provide the payer a 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, prior to payment. Form W-8ECI must include a U.S. EIN. Effectively connected income is reported under Exemption Code 01 on a Form 1042-S. The foreign organization must submit a Form 1120F income tax return.
A foreign organization that is resident in a country that has an income tax treaty in effect with the United States may choose to make a claim of exemption from tax under an applicable tax treaty provision. (The 4 percent excise tax on private foundations is not overridden by a tax treaty exemption because excise taxes are not covered by income tax treaties.) To make a claim under the tax treaty, the organization must meet the conditions for exemption and submit the claim to the payer on Form W-8BEN. The Form W-8BEN must contain a U.S. EIN in order for any type of treaty claim to be honored. The specific claim depends on the provisions available for tax exemption under the tax treaty.
Paula N. Singer, Esq. chairman of Windstar Technologies, Inc. and partner in the tax law firm, Vacovec, Mayotte & Singer, Newton, MA, has over 25 years of experience providing advice and compliance services to employers on cross-border employment matters. For more information, visit www.windstar.com. For additional information, call 1-800-259-6398 or email: firstname.lastname@example.org.
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