The IRS has begun to enforce the long-standing (but largely ignored) withholding and reporting obligations of organizations making payments to foreign entities and to foreign nationals who are nonresident aliens for federal tax purposes (collectively called “foreign persons”).
While domestic entities, U.S. citizens, and resident aliens (collectively called “U.S. persons”) are subject to income tax on their worldwide income, foreign entities and nonresident aliens are subject to tax only on their U.S.-source income. As a result, the withholding and reporting rules for payments to foreign persons are different from the rules for payments to U.S. persons.
Payers may document the U.S. or foreign status of their payees with a Form W-9 as a certificate of U.S. status or a Form W-8BEN as a certificate of foreign status. A U.S. taxpayer identification number (TIN) is required on Form W-9 to avoid 28 percent backup withholding, but no TIN is required on the Form W-8BEN used solely as a certificate of foreign status.
Payers must timely deposit withheld amounts using the deposit schedule provided in IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities. Payers required to deposit wages electronically must also deposit these other withheld taxes (called “1042 deposits”) electronically. Payers who fail to withhold and timely deposit the taxes are liable for the underwithheld taxes, plus penalties and interest.
Since foreign persons are not subject to U.S. tax on foreign-source income, it is important to document foreign-source income in contracts and invoices. A payment including unallocated U.S. and foreign-source income is subject to 30 percent withholding on the total payment. The beneficial owner of the income may allocate the income on a U.S. tax return (Form 1040NR for an individual or trust, Form 1120-F for a foreign corporation) to obtain a refund of the taxes withheld on the foreign-source portion of the payment.
Other exemptions from withholding are available under a Code or income tax treaty provision provided the beneficial owner of the income meets the conditions for the exemption. The beneficial owner is the one subject to tax under U.S. tax rules. The payer may allow the exemption from withholding only if the payer has a valid signed and dated withholding certificate (Form W-8BEN, W-8ECI, W-8EXP, W-9, or 8233) from the beneficial owner of the income prior to the payment being made. The form varies with the type of income, payee, and/or exemption being claimed. Withholding and reporting must be in the name of the beneficial owner of the income even if payment is made to a third party such as an agent.
Generally, for a withholding certificate to be valid for an exemption from withholding, it must include the beneficial owner’s U.S. taxpayer identification number (TIN). (A U.S. TIN is not required simply to make a payment subject to NRA withholding.) There is an exception for income on publicly traded investments and related loans. An individual beneficial owner must provide a Social Security number (SSN) or individual taxpayer identification number (ITIN). Other beneficial owners must provide an employer identification number (EIN).
A payer who knows (or has reason to know) that the beneficial owner is a foreign person, must withhold 30 percent. For purposes of these rules, personnel making the payments are deemed to know what anyone else in the organization knows about the payee.
If withholding was at the statutory rate, no U.S. TIN is required on Form 1042-S. Forms 1042-S reporting a payment exempt from withholding (except for treaty-exempt income on publicly traded investments) must generally have a U.S. TIN unless an exception is provided in the form’s instructions. Otherwise, the payer will be obligated to pay the underwithheld taxes plus penalties and interest and may be subject to a $50 penalty for failure to include a TIN on the form.
Payers filing 250 or more Forms 1042-S must submit them electronically through the IRS Filing Information Returns Electronically (FIRE) system. Payers issuing Form(s) 1042-S must also submit a Form 1042 tax return even if they did not withhold taxes from the payments. Failure to report timely and accurately can result in penalties and interest.ęCopyright 2010 by Windstar Technologies, Inc. Windstar reserves all rights to this electronic material. Information contained in this publication is based on the best information available at the time of publication. While believing the information in this publication to be accurate, Windstar accepts no legal responsibility for its accuracy
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. She is also the editor of "US Tax Compliance For Immigrants And Employers: The Lawyer's Complete Guide". To learn more, see: http://www.ilw.com/store/tax.shtm. 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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