Forms 1042, “Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,” and 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding,” must be filed by March 15 of the year following the close of the previous calendar year to report withholding on amounts paid to foreign payees. Filing of Form 1042 can be extended for six months by filing Form 7004, “Application for Automatic Extension of Time to File Certain Business Income Tax, Information, and Other Returns,” but filing does not extend the due date for furnishing statements to recipients. Payments subject to withholding generally include U.S.-sourced dividends, interest, royalties, rents, and certain services. Forms 1042-S and 1042 often are regarded as the counterpart to the Form 1099 series and Form 1096, “Annual Summary and Transmittal of U.S. Information Returns,” for payments to foreign persons for passive sources of income and services provided by nonresidents within the U.S. It is important to note that when a corporate distribution contains elements of both dividend and return of capital, two Forms 1042-S must be filed for each shareholder or investor.
For 2015 Forms 1042 due in March 2016, the penalty has increased from $100 to $250 for each 1042-S that is not filed with the IRS or provided to the payee, with a maximum penalty of $3 million. Financial institutions, whether domestic or foreign, are required to file Forms 1042-S electronically, regardless of the number of forms filed. “Financial institution” is broadly defined in this context and includes private equity funds, insurance companies, traditional banks, and expanded affiliated groups that contain these entity types. Other businesses are not required to file electronically until they have more than 250 Forms 1042-S. Failure to file electronically when required will result in additional penalties.
In January 2016 the IRS issued Notice 2016-08, which specifies the circumstances under which a withholding agent may rely upon electronically furnished Forms W-8 and W-9. The IRS indicated that it would issue regulations allowing the use of Forms W-8 and W-9 that have been collected and furnished electronically by a nonqualified intermediary, subject to certain systems requirements. This is welcome news for tiered partnerships and other withholding agents that are required to document and report payments to indirect payees with whom they otherwise may have little or no contact.
The Foreign Account Tax Compliance Act (FATCA) imposes a 30 percent withholding tax on withholdable payments to foreign payees. Foreign financial institutions (FFIs) are required to provide U.S. withholding agents with their global intermediary identification number (GIIN), which is used for FATCA compliance purposes. At the time FATCA was implemented, the regulations allowed entities related to FFIs, known as sponsored FFIs, to use the sponsoring FFIs’ GIIN through Dec. 31, 2015. Notice 2015-66, which was issued in September 2015, extended the time for which sponsored FFIs can use the sponsor’s GIIN through Dec. 31, 2016. Sponsored FFIs were required to notify the U.S. withholding agent that they were using the sponsor’s GIIN. Withholding agents, especially those in the financial services industry, should review their documentation to determine which FFIs will be required by the end of 2016 to provide their own GIIN. Beginning with payments made in 2017, any payments to sponsored FFIs that do not have their own GIIN may be subject to 30 percent U.S. withholding tax.
Under FATCA, 30 percent withholding will apply to the proceeds from the sale of stocks, bonds, or other income-producing assets if the seller has not provided the withholding agent a Form W-8 certifying its status for transactions occurring on or after Jan. 1, 2019. Notice 2015-66 extended the effective date of this provision, which originally was set to take effect on Jan. 1, 2017. These provisions are not without controversy, and the IRS may simplify the provisions prior to their effective date.