Many U.S. tax preparers have marked March 15 on their calendars, which is the first major due date for the 2021 tax season. Domestic flow-through entities such as partnerships and S Corporations with a calendar year-end must file their 2020 income tax returns or extensions by March 15, 2021. From the U.S. international tax compliance perspective, most foreign reporting forms follow the due date of U.S. owners, such as certain international information reporting forms for controlled foreign corporations, foreign partnerships and disregarded entities (Form 5471, 8865 and 8858). However, there are some international tax forms that have to be filed separately and may need separate extensions. This blog will discuss general compliance requirements of U.S. international information return Form 1042 (Annual Withholding Tax Return for U.S. Source Income of Foreign Persons) and Form 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding) as they have separate due dates as well as specific requirements for extensions. And how failure to file these forms properly could lead to significant monetary penalties.
FDAP INCOME FILING QUALIFICATIONS
When a foreign person has U.S. source fixed or determinable, annual or periodic (FDAP) income, such person may be subject to U.S. withholding tax. The person who made FDAP payments to the foreign person must reconcile such information when the calendar year is closed and provide the information to the IRS as well as to the foreign recipient. This information is reported on Form 1042 and Form 1042-S. Note that Form 1042 and 1042-S are also used to report certain payments subject to withholding under Foreign Account Tax Compliance Act (FATCA) or Chapter 4 of the Internal Revenue Code. Chapter 4 reporting is beyond the scope of this article.
The filers of Form 1042 and 1042-S are not limited to U.S. persons. In certain situations, FDAP payment made by a foreign person may also be subject to Form 1042 and Form 1042-S reporting requirements. For example, one foreign corporation conducting U.S. trade or business through an unincorporated U.S. branch made interest payments to a foreign person that does not have any U.S. business activities. The foreign corporation is still required to file Form 1042 and Form 1042-S to report the interest payments and maybe required to withhold tax.
Under the general rules, all U.S. source FDAP payments to non-U.S. persons is subject to 30 percent withholding tax and reporting requirements. The U.S. withholding agents (normally the U.S. payers) must withhold the 30 percent tax and remit it to the IRS
Depending on the type of FDAP payment, the sourcing rules may be different. For example, a dividend payment from a U.S. corporation should generally be treated as U.S. source FDAP, as the dividend income is generally sourced to the payor. A warranty payment from a U.S. corporation may not be treated as U.S. source if the warranty services were performed outside of the U.S. Warranty income is generally sourced to the jurisdiction where services were performed. Therefore, the first step is to determine whether the payment is U.S. source (subject to withholding) or foreign source (not subject to withholding).
FDAP INCOME FILING EXCEPTIONS
There are several exceptions to the 30 percent withholding tax, such as the impact of income tax treaties (reduction or elimination of withholding tax). However, the reporting requirement must still be met, and sometimes, additional reporting and documentation may also be required to claim the exceptions. For example, if the foreign recipient is able to use an income tax treaty to reduce or eliminate the withholding tax, the withholding agent must document eligibility to use the treaty – such as requesting a Form W-8BEN-E from the foreign recipient before making the FDAP payments. Annual Form 1042 and 1042-S must be filed to report the gross amount of the FDAP income regardless if there is an actual tax withholding. Additionally, Form 1042-S and recipient copies must be filed and issued regardless if withholding tax was applicable.
FORM 1042 and 1042-S HIGHLIGHTS
- Form 1042 and Form 1042-S are required when making FDAP payments to non-U.S. persons.
- Form 1042 is the annual reconciliation summary of all the payments to the non-U.S. persons. It can be used to claim a refund of over-withheld tax on the FDAP payments.
- Form 1042-S, used to report the FDAP payments to each non-U.S. person, must be filed together with Form 1042-T (Annual Summary and Transmittal of Form 1042-S).
A copy of Form 1042-S must also be issued to each respective FDAP recipient.
- The income codes on Form 1042-S are often updated by the IRS every year. Filers should review the codes and the form instructions carefully before preparing the forms.
- The Form 1042 filers with a large number of Form 1042-S filings can request a transcript from the IRS to reconcile the total amounts reported on Form 1042 to match with the Form 1042-S filed. For the Form 1042 filers with only a few Form 1042-S filings, it is best practice to file Form 1042 and Form 1042-S together to avoid mismatches. Mismatches or inconsistencies between the Form 1042 and Form 1042-S could be identified by the IRS and result in penalty assessments.
DUE DATES AND EXTENTIONS DEADLINES FOR FORM 1042 AND FORM 1042-S
- Due date: March 15, 2021
- An automatic six month extension is available for Form 1042. The extension should be requested by filing Form 7004 (different than Form 1042-S).
- Penalties applicable to Form 1042 and 1042-S
- Due date: March 15, 2021
- The filer can request an automatic 30-day extension for the filing deadline by submitting a Form 8809 (Application for Extension of Time). The extension can be requested online through IRS FIRE System or submitted with paper application. No signature is required for the automatic 30-day extension.
- Form 1042-S recipient copies must be issued by March 15, which can also be extended by faxing a request letter to the IRS at 877-477-0520 (International 304-579-4105). Additional information can be found in Form 1042-S instructions.
Refer to the chart below for penalties related to late filings or missing information.
|Specific Penalties||Amounts (Return Due in 2021)|
|Late filing of correct Form 1042-S within 30 days after the due date||$50 per Form 1042-S, annual cap at $571,000|
|Late filing of correct Form 1042-S over 30 days after the due date but before August 1||$110 per Form 1042-S, annual cap $1,713,000|
|Late filing of correct Form 1042-S after August 1 or failed to file correct Form 1042-S||$280 per Form 1042-S, annual cap $3,426,000|
|Intentionally disregard the requirement to file Form 1042-S||$570 per Form 1042-S, or 10% of the total gross amount, no annual cap.|
|Failure to furnish correct Form 1042-S to recipient||$280 per Form 1042-S, annual cap $3,426,000|
|Intentionally disregard the requirement to furnish Form 1042-S to recipient||$570 per Form 1042-S, or 10% of the total gross amount, no annual cap.|
|Late filing of Form 1042||5% of the unpaid tax for each month, up to 25% of the unpaid tax|
|Late payment of withholding tax||1.5% of the unpaid tax for each month, up to 25%|
If you have any questions regarding Form 1042 and 1042-S compliance, please reach our International Tax Services Team.
IRS Clarifies Form 1042-S Requirements for Withholding Agents; Outlines Common Errors