No Form 1042 extensions, higher penalties and no refunds – IRS changes its ways!

As readers may recall, in 2013 IRS launched a new foreign payment practices (FPP) division under the LB&I to specifically oversee withholding agents’ compliance activities. The short article is intended to make the withholding agents and other affected taxpayers/ tax professionals aware that FPP has recently begun proposing significantly higher penalties for late filing of Form 1042-S and 1042 by the withholding agents.

Generally, Form 1042 and 1042-S are required to be filed by the withholding agent with regard to the U.S. source income paid to the non-U.S. persons. The forms must be prepared for the calendar year regardless of the withholding agent’s taxable year. These Forms are due on or before March 15th of the following calendar year. They must also be furnished to the payees by the same date. 

Until recently IRS was granting a 30-day extension for filing Form 1042-S when they filed application for extension of time to file on Form 8809 on or before March 15th. Form 1042 can be extended for 6 months by filing Form 7004. IRS has recently proposed regulations that will limit granting the automatic extension with regard to Form 1042-S. IRS proposed regulations state that the extension will be allowed only under extreme circumstances and may be denied if no such circumstances exist. Withholding agents must be bear in mind that IRS may not grant extensions in future and it may be considered not only late but late with intentional disregard. 

In case of intentional disregard of filing Form 1042-S, the penalty is greater of $250 per form or 10% of the amount required to be reported. Based on the facts and circumstances, in order to prove intentional disregard, IRS must show that 1) The filer was required to file an information return, 2) filer knew or should have known about the requirement to file, and 3) deliberately chose not to file or ignored the requirement to file (this occurs in case of repeated failures or delays in filings). 

Now think about this in another perspective. In Notice 2015-10, IRS stated that it will consider the refund claim only if it can trace the withholding payment as actually paid. In case the IRS cannot trace that, no refund will be issued. This along with the difficulties in applying for 1042-S extensions and increased penalties, withholding agents are well advised going forward to implement a serious process to file the forms in a timely manner.

 

Form 1042 – IRS makes some important changes

Last month IRS made changes to the instructions of Form 1042 – Annual Withholding Tax Return for US Source Income of Foreign Persons. As the readers may recall, IRS made some changes to Form 1042 earlier to coincide with the newly issued FATCA regulations under Chapter 3 and 4. The updated instructions were released to assist the withholding agents in preparing the Form. It is pertinent to note that although 2014 and 2015 versions of the Form are identical, IRS has made certain parts of the Form which were optional in 2014, as mandatory for 2015.

Following parts of Form 1042-S are accordingly mandatory for 2015:

  • Withholding agent’s Chapter 3 and 4 status code must be entered on page 1 under the withholding agent’s name.
  • Reconciliation of U.S. source fixed or determinable annual or periodical (FDAP) income in section 2 of Form 1042 must be completed. This schedule reconciles the total U.S. source FDAP income subject to withholding under Chapter 4 with the total amount of U.S. source FDAP income reported on Forms 1042-S.
  • It is required that withholding agents now summarize the reasons why the amounts were not subject to Chapter 4 withholding such as amounts paid with respect to grandfathered obligations, amounts paid that were characterized as excluded nonfinancial payments, etc.).