1099 Tax Software Blog

Congress is serious about collecting information about, and taxes from, non-U.S. persons who earn U.S. income. The applicable law is the Foreign Account Tax Compliance Act, or FATCA, which has new provisions as of 2014. The purpose of FATCA is to ensure that withholding agents –foreign financial institutions and non-financial foreign entities — collect and report identifying information on withholdable payments to foreigners– nonresident aliens, foreign entities, foreign estates, publicly traded partnerships with foreign partners, and any other non-U.S. person or their agents. The IRS collects the information on Form 1042-S and imposes penalties for non-compliance.

FATCA Casts a Wide Net

FATCA affects just about every non-U.S. entity receiving most types of U.S. source income, including:

• Dividends
• Interest
• Rents
• Annuities
• Wages, salaries and other compensations
• Remunerations
• Gambling winnings
• Cancellation of indebtedness
• Emoluments
• Premiums
• Capital gains

Foreign students attending classes in the U.S. do not have to report scholarship funds.

The Act requires agents to withhold a 30 percent tax on the U.S.-source income of foreigners unless the agent and/or payee provide the required information, including a Taxpayer Identification Number, or TIN. To escape the 30 percent withholding requirement, a foreign financial institution (FFI) can enter into an agreement with the U.S. Treasury that requires the FFI to specify:

• Account numbers
• Account-holder information
• Account balance or value at year-end
• Income paid or credited to the account

Account holders typically report identifying information using Form 8233 or Form W-8 BEN. Withholding agents provide this information using Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. Alternatively, agents can go all-in and fill out a Form 1099 for each account holder.

A New Chapter

The original provisions of FACTA, known as Chapter 3, went into effect in 2010. Chapter 4 is new for 2014 and is primarily aimed at individuals with offshore accounts. It extends the requirements of FFIs and certain non-financial foreign entities (NFFEs) to provide account-holder information to withholding agents. The kicker in Chapter 4 is that an FFI that fails to report withholding information won’t receive any credit or refund on the withholding it collects.

Form 1042-S

The IRS changed Form 1042-S in 2014 to accommodate Chapter 4 withholding. The form itself gathers copious information about:

• Identity of the foreign person
• Identity of the withholding agent
• Exemption codes and tax rates
• Net income
• Amount withheld and repaid
• The identity of any intermediate entities

The form references several types of identification codes, including taxpayer, employer, global intermediary and foreign tax. The form requires much fact-finding and reporting, and the IRS has issued alerts about significant error rates because of incorrect or missing information.

Form 1042-S must be filed with IRS by March 15. A copy of the form must be sent to the foreign person by that same date. The filer must also fill out Form 1042-T, Annual Summary and Transmittal of Forms 1042-S

Support

Withholding agents and others who must file Form1042-S can simplify the job by outsourcing the work to a service bureau or by buying software the uses data files (in Excel or CSV formats) to populate the forms and then file them electronically. Agents must file the form even if it doesn’t withhold tax because of the nature of the income or because of a tax treaty. By the way, legitimate residents of U.S. territories and possessions do not require Form 1042-S reporting if they are a U.S. citizen, resident alien or national. If you must fill out Form 1042-S, you must also file Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons.

I receive this question often.  For the 1099 forms, if you have multiple transactions or payments to a recipient during a year, you don’t send them multiple 1099 forms.  Instead, send them one 1099 form with the totals for that tax year.

IRS Form 1042-S is the same as the 1099- forms in this regard.  If you paid someone multiple times, put together one 1042-S form at the end of the year to show the total amount paid and withheld and so forth.

Internal Revenue Service Form 1042-S, titled “Foreign Person’s U.S. Source Income Subject to Withholding,” must be filed for non-residents and foreign entities that have derived income or gains from investments in the US in the past year. These gains can include ordinary income dividends, long-term capital gains, or return of capital distributions. Gains from interests in US real estate also require reporting. Foreign corporations, foreign partnerships, foreign estates and foreign governments and foreign individuals should all list gains from US-based investments on the 1042-S form.

Other types of income that should be reported on Form 1042-S are: wages of employees who have claimed tax treaty benefits, fellowship/scholarship income, payments made to foreign independent contractors, royalty payments, and prizes or awards.

Form 1042-S includes a space to report withholding on investment distribution. Short-term capital gain and qualified interest income can be exempt from withholding (this exemption requires verification of the investor’s foreign status), as are long-term capital gains. Foreign persons or entities are not required to file a return if the withholding amount is equivalent to their tax obligation, or if they have not participated in income-generating trade or business inside the United States in the past year.

A 1042-S form should be filed by every withholding agent. This means an individual, a corporation, partnership or trust responsible for payment towards the foreign person’s income or investment gains. The withholding agent is defined this way regardless of whether actual withholding is required. Records of the form should be kept for three years after the original reporting date.

Every entity that engages in business with a foreign person, corporation or partnership is required to file a return for the income or capital gains they pay out. The benefit of this is that it allows non-resident alien individuals and foreign businesses to easily keep track of their investments, trading interests, and income sources within the United States.