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.
