Non-resident aliens such as foreign workers and students are subject to tax withholding when they work in the United States. The payments made by potential withholding agents (businesses, employers, etc) must be reported on Form 1042-S and submitted to the IRS. The tax treatment of non-resident aliens is different than for resident aliens, since the latter are taxed as US citizens, but payments still must be reported on the form as US-sourced income.
Even if a payment by a US withholding agent was made to a non-resident for services performed in a foreign country, the 1042-S must report those payments. Typically, payments of that nature would not be subject to withholding or taxation, but they still must be reported. This essentially requires any business or institution making payments to foreign workers to document and report the payments, regardless of where the services are performed or if they are taxable.
FATCA And Its Expansion Of 1042-S Reporting Requirements
FATCA (Foreign Account Tax Compliance Act) has effected some changes to the 1042-S reporting requirement. The primary purpose of FATCA is to identify US taxpayers who hold assets in foreign accounts, and requires those foreign institutions (FFI) to report their names and account holdings. Otherwise, US sourced payments would be subject to 30% withholding for non-compliance.
Also, the FATCA reporting requirement is being extended to non-financial foreign entities or persons that hold assets in US institutions or receive US-sourced payments, and that information will be reported on Form 1042-S. Obviously this expansion of FATCA is designed to uncover US citizens whose identities and foreign accounts may be shielded by foreign entities or persons, such as a trust or business partnership.
The Role of the Withholding Agent and Enforcement Under FATCA
Under the new FATCA guidelines withholding agents that would now include US businesses, banks and other financial institutions, must report the holdings and payments to individual non-resident account holders. These payments may be subject to FATCA enforcement mechanisms including a similar 30% withholding rate, despite the fact that the payments are being made to a non-financial foreign entity. Under FATCA, the term ‘withholding agent’ includes any person, US or foreign, that makes any type of payment to a foreign entity or person, a very broad class of payer.
This is an interesting evolution of FATCA and it places the reporting burden squarely on the one making the US-sourced payments. It allows the IRS to track any payment that originates with a US-based payer and is received outside the country. In essence, the tracking of payments under FATCA now identifies both US citizens and non-residents who receive any type of payment from a US source. The changes brought by FATCA have also resulted in a new Form 1042-S that will be used for the reporting year 2015 to reflect the July 1, 2014 start date for FATCA mandates.
Anyone who has financial dealings with foreign persons are potentially subject to the reporting and withholding requirements, and should be certain to document those payments or face penalties. There is a transition period in effect the first two years that will allow ‘good faith efforts’ of compliance to escape any potential penalties for under reporting of payments required by FATCA.
