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IRS Focuses on Form 1042 Examinations

The IRS has given its agents new guidance for conducting audits of taxpayers required to withhold tax and comply with reporting requirements for payments of income made to foreign persons.

February 2009
by Philip Pasmanik/The Tax Adviser

U.S. taxpayers have an obligation to file information reporting forms to report certain payments to foreign corporations, foreign individuals, foreign partnerships and certain foreign fiduciaries, trusts and estates. Generally, every U.S. person that makes a fixed or determinable payment of annual or periodic income (FDAP) from U.S. sources must withhold the proper amount of U.S. tax and remit it to the IRS. The rate of tax withheld on such payments is 30 percent. U.S. persons who make FDAP payments are required to file Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, is filed with the IRS and a copy is sent to the income recipient to report such FDAP payments and any associated withholding.

The 30 percent withholding rate can be reduced by various exceptions provided in the statute or by a reduced tax rate under a tax treaty between the United States and the country in which the foreign recipient of the U.S. source income resides. For certain types of payments, treaty-reduced withholding rates are available only if the beneficial owner of the payment provides the withholding agent with a withholding certificate that includes a taxpayer identification number. The withholding agent needs to carefully comply with this requirement because the agent is liable to the IRS for the amount of tax required to be withheld as well as for interest and penalties.

New IRM Provision

In July 2008, the IRS issued a new Internal Revenue Manual (IRM) section, U.S. Withholding Agent Examinations — Form 1042, which provides for an increased level of focus by IRS examiners to examine and enforce the statutory requirements for withholding and the related compliance reporting of FDAP-type payments to foreign persons.

The IRM is intended to cover two types of U.S. withholding agent audits.

This article has been excerpted from The Tax Adviser. Read the full article here (PDF).