By: Max Hattman
Form 1042 is the withholding tax return for foreign persons with U.S. source income that is required to be filed annually, by March 15th. If you are a U.S. company paying a foreign contractor that is working within the United States, you are likely required to file this form, accompanied with a Form 1042-S, and withhold taxes on the payments made and remit them to the IRS. Penalties and interest will accrue if you are required to file these forms and you fail to do so.
Form 1042 summarizes the withholding tax liability of the U.S. company that has made withholdable payments to foreign persons. The company/person that has made these payments to foreign persons is called a “withholding agent” by the IRS, and a withholding agent can be an individual, corporation, partnership, trust, or other entity.
The corresponding Form 1042-S is the personalized form that is delivered to each payment recipient, i.e, the foreign person. Also due March 15th, Form 1042-S also reports who the recipient of the payment is, the amount of the payment, any amounts withheld, type of payment made, etc. The most common withholdable payments include: compensation for services performed in the U.S., dividends, interest and royalties.
If you or your company have made any of the aforementioned payments to foreign persons, you may be required to withhold tax and report the payments on these forms. The standard withholding rate is 30% of the payment, unless a specific exemption or reduced rate is granted under a treaty agreement with the United States. The catch here is that if the tax required to be withheld on the payment is greater than $2,000, the tax must be remitted to the IRS three business days after the end of the “quarter-monthly period” that is reported on the Form 1042. The quarter-monthly periods end on the 7th, 15th, 22nd, and last day of each month. In order to successfully avoid penalties and interest, it is imperative to be prepared and knowledgeable of when withholding is required and due. Regardless of whether or not the payment requires tax to be withheld, it may still need to be reported on Form 1042-S.
Withholding agents who fail to file Form 1042 or Form 1042-S on time will be liable for interest and penalties. The standard penalty for failing to file Form 1042 is 5 percent of the tax owed per month late, but the penalty is capped at 25 percent. Failure to file form 1042-S will incur: $50 penalty per individual form, if filed within 30 days after the due date, with a maximum penalty of $565,000 per year; $110 per form, if filed more than 30 days after the date but prior to August 1st, with a maximum penalty of $1,696,000; and $280 per form, if filed after August 1st, with a maximum penalty of $3,392,000 per year.
Due to the complexities associated with determining if withholding tax is required; and if so, at what rate, it is highly recommended that you consult with a tax professional. HPG has a team of specialists who can assist with treaty analysis, character and source of income consulting, and preparation of the required forms, which may vary depending on your particular circumstances.