How can we help?

Where to find us

726 Exchange Street, Suite 822
Buffalo, NY 14210
Phone: 716-854-5034
Fax: 716-854-7195

Form 1042 and Withholding Requirements for Payments to Foreign Persons

Home / 

Before you or your company makes a payment to a foreign person, there are some withholding rules you need to be aware of.

Who is a foreign person?

Before knowing the withholding rules, it is important to understand whether the person/entity you are paying is considered a U.S. person/entity for tax purposes, or whether they are considered foreign. A foreign person is anyone who is not a U.S. citizen or tax resident, or any company not formed within the 50 U.S. states; examples include citizens of other countries, foreign corporations, foreign partnerships, or foreign estates/trusts. However, someone can be a U.S. tax resident without being a citizen; examples include those who hold green cards, or an individual present in the U.S. for more than 183 days in a given year.

What is a withholding agent, and what are their responsibilities?

When payments are made to a foreign person, one entity involved in the transaction is considered the “withholding agent”: the withholding agent is defined as a “U.S. or foreign person that has control, receipt, custody, disposal, or payment of any item of income of a foreign person that is subject to withholding.” According to the IRS, the withholding agent is “personally liable for any tax required to be withheld, as well as interest and any applicable penalties”; that means if the correct amount is not withheld from the payment, the IRS will hold the withholding agent liable for any unpaid tax, along with applicable interest and penalties. To avoid this, the withholding agent should make sure to keep good records on who they are paying; getting signed W‐8s and W‐9s is a great way to keep track of who is or is not a foreign person.

How do you know if a payment requires withholding?

A payment to a foreign person requires withholding if it is considered Fixed, Determinable, Annual, or Periodical (FDAP) income. FDAP income is generally all income, except gains from the sale of real or personal property, and income items excluded from gross income, such as tax‐exempt municipal bond interest, qualified scholarship income, etc. FDAP income is generally taxed at a flat rate of 30%, unless a tax treaty exists between the U.S. and the payee’s country that lowers it. For example, if a dividend is paid by a U.S. company to a Canadian company, the U.S. – Canada income tax treaty lowers the withholding rate on dividends to 15% rather than 30%.

What forms need to be filed?

In order to report the payment and withholding, the withholding agent must file Form 1042: Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. Its purpose is exactly what it sounds like: to report withheld taxes on payments to foreign persons. Three forms in total must be filed: Form 1042, to report the withheld taxes, Form 1042‐S, which is an information return for each payee, and Form 1042‐T, the summary of all Forms 1042‐S that are filed.

Form 1042 is due March 15th of the year following the calendar year in which the income was paid; for example, if a payment was made in tax year 2023, the Form 1042 would need to be filed by March 15th, 2024. Form 1042 must also be paper filed, unless the payor has an active registered user account for the IRS’s e‐Services; if there is an active account, Form 1042 may be electronically filed via the IRS’s Modernized e‐File (MeF) system.

Form 1042 may also be extended with Form 7004, but like other tax return extensions, Form 7004 does not grant an extension of time to pay the tax; it must still be paid by March 15th.

How do you pay the tax, and what are the potential penalties?

The IRS requires the use of the Electronic Federal Tax Payment System (EFTPS) to make the deposit of withheld tax. The tax must be sent to the IRS via the EFTPS before Form 1042 can be filed – once confirmation of payment is received, then the payor must file Form 1042. If the EFTPS is not used, the payor can be subject to penalties up to 10% of the withholding.

If the payment is made late, the IRS may assess penalties of .5% of the unpaid tax, each month the tax is late up to a maximum of 25%. If Form 1042 is filed late, a penalty may be assessed of 5% of the unpaid tax for each month the form is late, up to a maximum of 25%. In addition, other penalties exist for negligence, substantial understatement of tax, or fraud.

As mentioned, it is important to understand these rules if you or your company is planning on making payments to a foreign person. Making sure you understand you or your company’s role and responsibilities, as well as keeping good records on the people or entities you are paying are great ways to make sure you are in compliance with IRS regulations. For more information or if you have questions, feel free to contact us.

Written by Staff Accountant, Hannah Boothe