Who is Impacted
Anyone making payments of U.S. source fixed, determinable annual, or periodical income to non-U.S. persons will be interested in the updates for this reporting season of 2019 information in 2020.
Over the last decade, we have seen both subtle and not so subtle changes to the Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding. This year, the trend continues with some additional updates and specific details – some related directly to the final regulations published in December 2019. Let’s take a look at the new 2019 Instructions to Form 1042 that we received this month in February 2020!
On December 18, 2018, the Internal Revenue Service (IRS) and Department of Treasury (Treasury) issued proposed regulations that updated certain requirements under chapters 3 and 4 of the Code. Specifically, for 2019 reporting, a withholding agent may rely on two provisions of the proposed regulations when completing its Form 1042. The first relates to withholding and reporting in a subsequent year and the second relates to adjustments and overwithholding under the reimbursement and setoff procedures. These two provisions are included below, including a discussion of other new items to be aware of for 2019 returns.
2019 Instructions for Form 1042, published on February 2, 2020
Rounding. The 2019 Instructions now require withholding agents to round amounts so that only whole dollar amounts are reported. In the section Rounding off to whole dollars, we have a specific instruction that taxpayers must round off cents to whole dollars. One important note, individual amounts are not rounded, only the total amount to be reported!
Withholding and reporting in a subsequent year. Partnerships or trusts that are allowed to withhold in a subsequent year (assume 2020) with respect to a non-U.S. partner’s or beneficiary’s share of income for the prior year (assume 2019) may designate the deposit of the withholding as attributable to the preceding year (assume 2019) and report the associated amounts on Forms 1042 and 1042-S for the preceding year (assume 2019). This keeps all of the withholding and reporting in the same calendar year and avoids the confusing lag that partnerships and trusts were using previously.
In the 2019 Instructions for Form 1042, we see a new section under the section Foreign Partners of U.S. Partnerships and Foreign Beneficiaries of U.S. Trusts on page 6. The new subsection is titled ‘withholding and reporting in a subsequent year’ and describes what happens when a partnership or trust reports the associated amount and tax withheld on Forms 1042 and 1042-S for the preceding year. If a partnership withholds on a foreign partner’s share of income after March 15 of the subsequent year, the due date for filing the applicable Form 1042-S is September 15 of the subsequent year.
Thankfully, the IRS has provided an example. Assume a partnership withholds on April 1, 2020, with respect to a foreign partner’s share of undistributed income for the 2019 calendar year. The partnership may designate the deposit as made for 2019 and report the liability and tax withheld on the 2019 Form 1042 and the 2019 Form 1042-S for the partner. This is an important point - the partnership or trust must confirm that its chapter 3 status code properly reflects its status as a partnership or trust (not a Financial Institution). This includes status as a Withholding Foreign Partnership or Withholding Foreign Trust. Partnerships and trusts must be sure that the enter partnership or trust or Withholding Foreign Partnership or Withholding Foreign Trust as applicable. A chapter 3 status should not include U.S. or non-U.S. Financial Institution. An important note!
Next, we have some detailed instruction on where to enter the withheld amount and liability. Partnerships and trusts applying these rules must report the associated liability on line 59 as the tax liability for the period ending December 31. They must report the share of income to the partner or beneficiary on line 62 for Total Gross amounts Reported on all Forms 1042-S, and the amount withheld on line 65b, Total paid during subsequent year.
The IRS notes that reporting in the preceding year is also permitted when a partnership or trust allocates a share of the income allocable to a partner or beneficiary attributable to the preceding year that was not distributed during that year, provided that the partnership meets the previously referenced due date of September 15, 2020, for the applicable Form 1042-S.
The IRS further notes that a U.S. partnership or trust may apply the proposed regulations for 2019 in lieu of the reporting otherwise described. The proposed regulations may also be applied by a non-U.S. partnership or trust that itself withholds as described in the Instructions.
Adjustments to overwithholding under the reimbursement and set-off procedures. Withholding agents may make adjustments to overwithholding using either the reimbursement or setoff procedures until the extended due date for filing Forms 1042-S – that is, unless the Form 1042-S has already been filed or furnished to the recipient. A withholding agent may use the extended due date for filing a Form 1042 to claim a credit for any adjustments made to overwithholding.
Section 871(m) transition delayed further. On December 16, 2019, Treasury and IRS issued Notice 2020-2, 2020-3 I.R.B. 327, announcing their intention to amend the section 871(m) regulations to further delay the effective/ applicability date of certain rules in those final regulations and certain requirements of a qualified derivatives dealer (QDD).
New Schedule Q (Form 1042). If the taxpayer, or any branch of the taxpayer, is a QDD, then it must attach to Form 1042 a Schedule Q (Form 1042), Tax Liability of Qualified Derivatives Dealer (QDD), for each QDD. This new Schedule Q (Form 1042) is used to provide information regarding a QDD's tax liability and replaces the previous requirement to attach a statement to the Form 1042.
How to Implement
Withholding agents required to file Forms 1042 this year should consider the following:
• Be sure to choose the most specific chapter 3 and chapter 4 status codes that apply to the withholding agents, intermediaries, where applicable, and recipients.
• Confirm that your tax reporting packages and software are rounding to the nearest dollar amount.
• If a withholding agent thinks there is a chance there could be any September 15 filings, it should request an extension to file Form 1042. If the withholding agent does not request an extension, consider filing an amended Form 1042 by September 15 and make timely deposits.
• As a warning, there is a good chance that partnerships and trusts using the new rules under the proposed regulations might receive a late filing penalty. This is because the systems may not be updated in accordance with the new rules. This is why it is very important to be sure the Forms 1042 are complete and accurate, with the correct chapter 3 partnership or trust status codes, and supported by workpapers.
• Look for the new 2020 Forms 1042 and 1042-T which will include additional fields and codes. Check with vendors and tax reporting packages to be sure that they are aware of these updates.
• Expect late filing notices for Forms 1042-S filed for the September 15 filing deadline for this first year of reporting based on the new regulations.
• Update policy and procedure manuals, training materials and presentations to staff.