Penalties For Failure To Comply With NRA Withholding And 1042-S Information Reporting
On August 4, 2010 the IRS announced, “executing our international strategy is a top priority, and our work continues to intensify in this area.” Included in this strategy is a requirement for examiners to review withholding and reporting on payments to foreign individuals and entities during corporate audits. Other organizations should anticipate that the IRS will apply what they learn in corporate audits of Accounts Payable to audits of their organizations as well.
Under long-standing rules and regulations, payers making payments of U.S.-source income to foreign persons are required to collect a 30 percent withholding tax on the gross income unless an exception applies. For an exception to be valid, the payer must follow prescribed procedures, including collecting appropriate and valid withholding certificates from the recipient prior to payment. Withheld taxes must be deposited timely. The gross income and taxes withheld (if any) must be reported on a Form 1042-S information return filed with the IRS and sent to the recipient by March 15th of the calendar year following the payment.
The IRS enforces compliance with these rules by requiring the payer (called a “withholding agent” because of the obligation to withhold taxes) to make periodic payments of withheld taxes (the due date varies with the amount of the liability) and imposing penalties for the failure to comply with withholding and reporting rules. The Small Business Jobs Act included increased penalties for failure to report income timely (described below) for payments required to be reported on or after January 1, 2011. Payers making payments of U.S.-source income to foreign persons should expect the IRS to be diligent in collecting the following penalties:
A. Penalty for Late Deposit The IRS prescribes when deposits of NRA (nonresident alien) withholding are required in IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities. A payer who fails to make a required deposit of withheld taxes within the time prescribed is liable for a penalty on the underpayment (i.e., the excess of the required deposit over any actual timely deposit for the period).
The penalty rate is based on the number of days that the deposit is late:
If the late deposit is not made within 10 days after the IRS issues the first notice demanding payment, the penalty is 15 percent. A withholding agent may be able to abate the penalty by showing that the failure to timely deposit was for reasonable cause and not because of willful neglect.
The tax liabilities and deposits must be listed on Form 1042 quarterly by month. The date for tax liabilities is the date paid (or deemed paid under constructive receipt principles). The date for deposits is the date the deposit is made.
B. Failure to Report Timely
1. Late IRS Forms 1042-S Submission
A small business is defined as a business having average annual gross receipts of $5 million or less for the three most recent tax years (or the period of existence of the business if shorter) ending before the calendar year in which the Forms 1042-S are due.
If a withholding agent intentionally disregards the requirement to report correct information, the penalty per Form 1042-S is increased to $250 or, if greater, 10 percent of the total amount of the items that must be reported, with no maximum penalty.
2. Late Forms 1042-S for the Recipient
The penalty is based on when the correct Form 1042-S is submitted and the number of forms filed as described above for the IRS submission. However, if a recipient statement is provided before August 1st for which the payer provides reasonable cause, the recipient statement shall be treated as if timely filed. The number of statements to which this de minimis rule applies may not exceed 10, or .5 percent of the total number of recipient statements required to be filed by the payer, whichever is greater.
C. Failure to File Forms 1042-S Electronically
The penalty applies separately to original returns and amended returns.
D. Failure to Timely Submit Form 1042
The penalty cannot exceed 25 percent of the tax due. For a Form 1042 filed more than 60 days late, the penalty is $100 or the balance of the tax due on the Form 1042, whichever is smaller.
E. Trust Fund Taxes
An employer or withholding agent that can show that the employee or payee paid the tax will not be liable for the tax. Currently, the only form specified for collecting a payee’s certification that their taxes have been paid is Form 4669.
Paula Singer, Esq., Co-founder and Chair of Windstar Technologies, Inc. and partner in the tax law firm, Vacovec, Mayotte & Singer LLP, Newton, MA, has over 25 years of experience providing advice and compliance services to individuals and their employers, and payers on cross-border matters.
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