Articles & Alerts

Mastering U.S. Tax Reporting for Foreign Payments: Form 1042 and Form 1042-S

Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and the accompanying Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, are crucial in reporting payments made to foreign individuals and entities. These annual filings are due on a calendar year basis and need to be filed by March 15th, following the end of the prior tax year. They are designed to ensure compliance with the U.S. withholding regime, which requires the withholding of taxes on certain payments directed outside the U.S. However, not all payments to foreign parties are subject to withholding, making the reporting process a nuanced endeavor.

In this alert, we’ll delve into the intricacies of Form 1042 and Form 1042-S, shedding light on their purpose and the underlying regulations.

Under the Internal Revenue Code, a withholdable payment is any payment of interest, dividends, rents, salaries, wages, and royalties. These payments are typically subject to a 30% withholding requirement, with some exceptions. If the payment falls under an exemption, then the payment may avoid the withholding requirement. However, the applicability of a withholding exemption does not necessarily alleviate a 1042 filing obligation.

The current U.S. withholding regime targets payments directed outside the U.S. This regime primarily focuses on what are known as “fixed, determinable, annual, or periodical” payments. These payments, made by U.S. entities to foreign recipients, are subject to withholding, with rates potentially reaching up to 30%.

To mitigate the withholding of U.S. income taxes, particularly with respect to service income, a non-U.S. entity can claim such income as:

  • Not considered U.S. source income;
  • Not effectively connected income to a U.S. trade or business; or
  • Considered either or both of the above, but is able to obtain the benefit of a tax treaty should the vendor be established in a country that has an income tax treaty with the U.S.

From a practical perspective, you almost certainly have a 1042 filing requirement if you have received a version of a Form W8 from a vendor, which is used to identify the type of entity receiving the payment. In a similar vein, taxpayers often find it easier to gain an understanding of the 1042 filing requirement by comparing it to the Form W9, Request for Taxpayer Identification Number and Certification, and a version of the Form 1099 regime, which pertains to payments made to domestic vendors in the U.S., but in this case, Form 1042 applies to foreign recipients of payments.

With respect to the compliance aspect, Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, is used to report payments made to all foreign persons and any income tax withheld on such payments. Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, is used to report payments made to each foreign individual and entity. A withholding agent that paid any amount subject to withholding to a foreign recipient must submit a Form 1042-S to the IRS and provide a copy to the employee or business. Additionally, Form 1042-S must be filed alongside Form 1042-T, which summarizes all Forms 1042-S submitted.

Navigating the complexities of Form 1042 and Form 1042-S in the U.S. withholding regime requires a deep understanding of tax regulations and compliance provisions. For more information about Form 1042 and Form 1042-S, please reach out to Kevin Brown or Gwayne Lai from Anchin’s International Tax Group, or your Anchin Relationship Partner.