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New IRS Practice Unit for “Adjustments for Overwithholding on Form 1042”

2020-04-08

Yesterday the IRS published a new practice unit titled “Adjustments for Overwithholding on Form 1042.” This practice unit discusses adjustments for overwithholding of tax done on payments of U.S. source income to foreign persons on Forms 1042 tax returns and Forms 1042-S information returns.

As discussed in the practice unit, how corrections to overwithholding are made depends on the timing of when the overwithholding is discovered. Three time periods are discussed:

  1. Before last deposits for the year,
  2. Before Form 1042-S due date (with additional limitations), or
  3. After that.

1. A withholding agent that discovers overwithholding before the withholding agent’s final deposits are made for the year can make balancing payments to the payees and to the IRS. In this case the withholding agent never needs to report the errors or corrections to the IRS.

2. A withholding agent that has overwithheld and already completed its deposits for the calendar year but whose Forms 1042-S have neither been sent out nor are overdue, may adjust the overwithheld amount using one of the following methods:

  1. a. Reimbursement Procedure (Treas. Reg. §1.1461-2(a)(2)) or,
  2. b. Set-off Procedure (Treas. Reg. §1.1461-2(a)(3)).

3. A withholding agent that discovers overwithholding after the Form 1042-S has been filed (or after its due date, including extensions) must report the overwithholding on Form 1042-S and the recipient must claim a refund for the overwithholding.

The practice unit notes that overwithholding “[m]ost commonly * * * seems to occur because a payee has not supplied complete documentation that allows a [withholding agent] to withhold less than 30%.” Typically, this would mean that the payee has not provided a Form W-8BEN or W-8BEN-E.

We have added this practice unit to our Practice Units By Topic page.

Tags: 1441 U.S. Withholding Taxes, Form 1042, Other - IRS Practice Units

Chart of Central de Gas de Chihuahua

2014-02-22

Below is a chart of Central de Gas de Chihuahua v. Commissioner, 102 T.C. 515 (1994).  The Tax Court held that the Code §482 adjustment made by the IRS was appropriate where one Mexican corporation, Central Gas, allowed a related Mexican corporation the rent-free use of tractors which were used in the U.S.  The Code §482 adjustment created deemed rental payments to Central Gas which were U.S. source income.

The chart can be viewed as a PDF file here: Central de Gas de Chihuahua.

We will shortly add this chart to andrewmitchel.com, where you can find hundreds of similar situational charts.

For some recent commentary on transfer pricing, visit Paul Caron's TaxProf Blog.

Central de Gas

Tags: 482 Transfer Pricing, 1441 U.S. Withholding Taxes, Charts - Situational Charts, Country - Mexico, Form 1042

Form 1099 for Payments to Foreign Contractors for Services?

2012-10-07

UPDATE - 9/23/14:  For payments to foreign ENTITIES, see our blog post Payments to Foreign Entities: Form W-8BEN-E.

UPDATE - 7/22/16:  For a discussion of substantiating deductions for payments to foreign contractors, see our blog post Substantiation of Deductions to Foreign Contractors.

One question that often comes up is how a domestic U.S. business should treat payments to a foreign contractor for services performed outside the U.S.  Is a Form 1099 required?  Is withholding required?

As long as the foreign contractor is not a U.S. person and the services are wholly performed outside the U.S., then no Form 1099 is required and no withholding is required.

Not a U.S. Person

So, how do you “know” that the foreign contractor is not a U.S. person?  If the contractor is an individual, perhaps he or she is a U.S. citizen living outside the U.S.?  While you may be able to rely on certain presumptions regarding the foreign contractor’s status (Treas. Reg. §1.1441-1(b)(3)), it is generally easier to simply ask him or her to complete a Form W-8BEN.  By signing Form W-8BEN, the foreign contractor is certifying that he or she is not a U.S. person.

In this circumstance there is no need for the foreign contractor to get a U.S. taxpayer identification number or to complete Part II of Form W-8BEN.  All that the foreign contractor needs to do is to complete the basic information in Part I and sign in Part III, attesting that the information is true, correct, and complete.  No Form 1099 then needs to be filed for payments to foreign persons.  Treas. Reg. §1.6041-4(a).

The Form W-8BEN is not filed with the I.R.S.  It is kept on file with the U.S. payor in case the U.S. payor is audited.  If audited, the Form W-8BEN supports why no Form 1099 was issued and why no tax was withheld.

Where Were the Services Performed?

Now that you know that the foreign contractor is not a U.S. person, how do you know that he or she is not performing some or all of the services in the U.S.?  Perhaps he or she spends two or three months a year at his or her second home in the U.S. and he or she works on your project while in the U.S.?

You won’t know if the services are performed in the U.S., unless you ask.  There is no special form for this.  The easiest way is to get a signed statement from the foreign contractor that he or she will not perform any of the services in the U.S.  It is typically best to attach this statement to the W-8BEN.

Form 1042 must be filed with respect to certain payments to foreign persons.  Code §1461 and Treas. Reg. §1.1461-1.  However, Form 1042 is required only for payments of “U.S. source income.”  If the payments are for services and the services are performed outside the U.S., then the payments will be foreign source income (Code §861(a)(3) and Treas. Reg. §1.861-4), and no Form 1042 will be required.

When in Doubt, Withhold

Say that you have some reason to doubt the veracity of the foreign contractor’s statements.  Perhaps you know that he or she was born in the U.S. (which would make him or her a U.S. citizen, unless he or she renounced his/her U.S. citizenship)?  Perhaps you know that the foreign contractor spends a good amount of time in the U.S. and you believe some of the services may be performed in the U.S.?

If you do not withhold tax on the payments to the foreign contractor but you are required to withhold, then you, as the payor (i.e., the “withholding agent”), can be held liable for the tax that you did not withhold.  Treas. Reg. §1.1441-1(b)(7).  Thus, if you are uncertain as to whether you need to withhold, it is generally better to withhold.  If the foreign contractor does not owe U.S. tax, then he or she can file a U.S. tax return and claim a refund for the tax that was withheld.

Tags: 1441 U.S. Withholding Taxes, Form 1042, Form W-8 BEN / BEN-E

International PLRs of the 10th week of 2012

2012-03-16

Last week the IRS published the following Private Letter Rulings and Chief Counsel Advice relating to international taxation.  There were no PLRs or CCAs for the 9th week and no international related PLRs or CCAs for the 11th week.

PLR 201210009:  Late Canadian registered retirement savings plan ("RRSP") deferral election.  The following is a quote from the PLR:

[The Taxpayer] retired and became eligible to receive benefits from two Canadian pension plans.  In addition, [the Taxpayer’s] mother, a Canadian citizen and resident, passed away in Year 3.  Because of these two events, [the Taxpayer] started doing independent research on various tax issues and he consulted a local accounting firm.  At this point, [the Taxpayer] first learned of the potential tax issues concerning RRSPs, including the need to make an election to defer U.S. taxation on income accruing in an RRSP pursuant to Article XVIII(7) of the United States-Canada Income Tax Convention (the “Treaty”).  In an effort to become and remain fully compliant, [the Taxpayer] retained tax attorneys with experience in international issues.

PLR 201210013:  Late Canadian registered retirement savings plan ("RRSP") deferral election.  The following is a quote from the PLR:

Taxpayer independently learned about the IRS offshore accounts tax compliance initiative by reading a newspaper.  Taxpayer performed independent research and became aware of the provision in the Treaty that provides for deferral of U.S. taxation of income accruing in an RRSP until there is an actual distribution of income from the plan.  Shortly thereafter, Taxpayer consulted a law firm to confirm his understanding of his U.S. tax obligations with respect to his RRSPs.  He was informed that in order to defer U.S. taxation on his RRSPs, an election must be made pursuant to Article XVIII(7) of the Treaty and Rev. Proc. 2002-23.  He also was informed about the requirement to file Forms 8891.

PLR 201210017: Late/retroactive passive foreign investment company ("PFIC") qualified electing fund ("QEF") election.  Treas. Reg. §1.1295-3(f).

PLRs 201210019 and 201210020: Domestic corporations were granted permission to change from the fair market value method to the alternative tax book value method of asset valuation for purposes of apportioning interest expense for their taxable years and for all subsequent taxable years.  Temp. Treas. Reg. §§1.861-8T(c)(2) and 1.861-9T(g)(1)(ii).

CCA 201210033:  The subject of the email is “6651 applicable to failure to file form 1042?” and the full text of the email is:

An addition to tax is imposed under section 6651(a)(1) for failure to file a return required under the  authority of Subchapter A of Chapter 61 (other than Part III) within the prescribed period.  § 6651(a)(1).   Form 1042 is a return required under the authority §6011, which is in Part II of Subchapter A of Chapter  61.  §6011(a); Treas. Reg. §1.6011-1(c); Treas. Reg. § 1.1461-1(b)(1).  See Ellwest Stereo Theatres of  Memphis, Inc. v. Commissioner, T.C. Memo. 1995-610, at *4; New York Guangdong Finance, Inc. v.  Commissioner, 588 F.3d 889 (5th Cir. 2009).  Therefore, failure to file Form 1042 will result in a penalty  under §6651(a)(1).

Tags: 894 Treaties, 1291 PFICs, Authority - PLRs / CCAs, Form 1042, Form 8891

Foreign Vacation Homes & Rental Properties

2008-02-08

U.S. residents with foreign vacation homes and foreign rental properties may unwittingly be subject to U.S. tax on interest paid to foreign banks.  A 30% tax is imposed on U.S. source interest received by foreign corporations.  Code §881(a)(1).  Interest is sourced in the U.S. if the obligor is resident in the U.S.  Code §861(a) provides:

The following items . . . shall be treated as income from sources within the United States . . . . (1) Interest from . . . obligations of noncorporate residents . . . .

Although the tax is technically imposed on the foreign lender, the person making the payment is required to withhold the 30% tax and can also be held liable for the tax.  Code §§1441, 1442, and 1461. U.S. citizens and aliens residing in the U.S. that have borrowed to purchase real estate outside the U.S. are typically astonished to learn that this tax exists, and that they can be held liable for the tax.

  • This is not a purely theoretical matter.  In Housden v. Commissioner, 63 TCM 2063 (1992), a U.S. resident individual had existing loans from a Canadian bank prior to moving to the U.S.  After he moved to the U.S., he continued to make payments on the loans from the Canadian bank.  The Tax Court held that he was liable for the withholding tax.  For a chart of this case, see Housden.

Income tax treaties between the U.S. and foreign countries typically reduce the withholding tax rate.  However, if you want to rely on the treaty, you need to obtain a Form W-8BEN, Certification of Foreign Status of Beneficial Owner for United States Tax Withholding, from the foreign bank where the bank certifies that it qualifies for treaty benefits.  Regardless of whether a lower treaty rate applies, Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons (and Form 1042-S) generally must be filed to report the interest payments to foreign persons.

For U.S. citizens residing outside the U.S., this tax does not apply.  As indicated above, sourcing is based on the residence of the obligor.  Thus, if a U.S. citizen resides outside the U.S., the interest will be foreign source income and there will be no withholding tax.

If the foreign lender is not a bank, it may be possible to structure the loan in a way that avoids the tax under the "portfolio interest exception."  Code §§871(h) and 881(c).  However, banks acting in the ordinary course of business cannot qualify for the portfolio interest exception.  Code §881(c)(3)(A).

Tags: 1441 U.S. Withholding Taxes, Form 1042