Ensure Your U.S. Accounting Team knows International Tax
The IRS is hiring and training more than 3,000 agents to enforce its Foreign Account Tax Compliance Act (FATCA). If your US tax team is unfamiliar with International Tax Issues, you may be putting yourself and your business at risk.
Validating tax information, especially for global partners, can reduce the likelihood of paying out to “suppliers” who are actually fraudsters or criminals. The IRS is also making Form 1042-S filings part of the standard tax return examination. Organizations are generally aware of the need to report 1099 income, but it seems that many are not so aware of the even greater compliance required for reporting payments made to foreign entities.
Forms 1042, 1042-S and 1042-T are United States Internal Revenue Service tax forms dealing with payments to foreign persons, including non-resident aliens, foreign partnerships, foreign corporations, foreign estates, and foreign trusts.
Every withholding agent or intermediary, whether U.S. or foreign, who has control, receipt, custody, disposal or payment of any fixed or determinable, annual or periodic U.S. source income over foreign persons, must file these forms with the IRS. For example, employers that employ non-resident aliens (such as foreign workers or foreign students) would need to file a 1042-S Form with the IRS for every non-resident alien they employ and also send a (completed) copy of that form to the non-resident alien they employ.
Forms 1042 and 1042-S are filed separately. The main difference between forms 1042 and 1042-S is that form 1042-S is concerned with payments made to foreign persons, while form 1042 is concerned with determining how much income will be withheld for tax withholding purposes. Also, Form 1042-S must always be filed together with Form 1042-T, but Form 1042 can be filed by itself.
Form 1042-S payments are subject to withholding. The withholding level is:
- 14% if the payee is in F, J, M, or Q status and has a valid Taxpayer Identification Number,
- 30% otherwise.
Comparison with Forms 1099 and 1099-MISC
Form 1099 is one of several IRS tax forms used to prepare and file an information return to report various types of income other than wages, salaries, and tips (for which Form W-2 is used instead). Form 1099-MISC is a variant of Form 1099 used to report miscellaneous income. As a general rule, if the person receiving the withholdable payment is a nonresident alien, Forms 1099 and 1099-MISC should not be used, and instead Form 1042-S should be used.
One use of Form 1099 is for reporting gross rent on property. However, for example, if a property manager manages property owned by nonresident aliens, the manager must issue the nonresident alien owner a Form 1042-S, not a Form 1099.
A common use of Form 1099-MISC is to report amounts paid by a business to a non-corporate US resident independent contractor for services. If the independent contractor is a nonresident alien, then the business must instead use Form 1042-S.
It is important to note that Form 1042 is not merely the nonresident payee analogue of Form 1099. There are a few important differences:
- Forms 1099 and 1099-MISC usually do not require any withholding, except in cases where the payee does not provide a correct Taxpayer Identification Number (TIN), the payee has been reported for underpayment, or there has been a payee certification failure. In contrast, Form 1042-S is accompanied by tax withholding.
- The various Form 1099s have reporting thresholds (for instance, Form 1099-MISC needs to be filed only if $600 or more is being paid). However, Form 1042-S needs to be filed for any payment.
- There are contexts where no Form 1099 (or any other form) needs to be filed for resident payees, but Form 1042-S needs to be filed for nonresident payees. These include scholarship income, as well as payment for personal services (i.e. payment for services that fall outside a business−contractor arrangement, such as payment for household help).
Comparison with Form W-2
Form W-2 is issued for work done as an employee to all US citizens and residents and is issued to foreign employees who either don't fall under a tax treaty, or whose earnings exceed allowable maximums of a tax treaty. Form 1042-S is not used only for
- Form 1042-T
- Form 1042-T, also "Annual Summary and Transmittal of Forms 1042-S", is used to transmit Form 1042-S to the Internal Revenue Service. Form 1042-T is simply a 1-page summary of Form 1042-S. This form (along with Form 1042-S) is submitted to the IRS only, not to the non-resident alien. A separate Form 1042-T must accompany each type of Form 1042-S, but multiple Forms 1042-S (corresponding to more than one payee) can be grouped under a single Form 1042-T.