Time For A Withholding Tax Check-Up

COL. COLUMNS I tax practice & procedure
Time for a Withholding Tax Check-Up
By Megan L. Brackney
If it is not already on the schedule, CPAs should remember to talk to business clients about withholding on payments to nonresident aliens. A withholding agent who fails to withhold when required may be on the hook for the withhold- ing tax liability, as well as potential penalties for failure to file Forms 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. The IRS has been increasing enforcement in this area after forming a special group, the Foreign Payments Practice (FPP), in 2013 to focus on the administration and enforcement of the withholding rules.
holding obligation is imposed under Internal Revenue Code (IRC) sections 1441 (for individuals) and 1442 (for corpora- tions), which require, with certain exceptions, withholding agents to withhold on U.S.–sourced income, including interest, dividends, rent, salaries, wages, premiums, annuities, compen- sation, remuneration, emoluments, and other fixed or deter- minable annual or periodic (FDAP) gains, profits, and income. Certain gains and payments of original issue discounts (OID) are also subject to withholding under sections 1441 and 1442. There are many exceptions to these rules. For example, with- holding does not apply to payments of income effectively con- nected with a U.S. trade or business [Treasury Regulations section 1.1441-4(a)(1)], payments for services performed out- side the United States [Treasury Regulations section 31.3401(a)(6)-1(b)], or for payment of portfolio interest under IRC sections 871(h) and 1441(c)(9). Also, tax treaties may reduce or eliminate withholding on interest, dividends, and other specified categories of FDAP (Treasury Regulations sec- tion 1441-6].
Failure to fulfill the obligations of a U.S. withholding agent can have serious consequences for employers.
The concept of a withholding agent is very broad, and it includes any person, U.S. or foreign, that has control, receipt, or custody of an amount subject to withholding who can dis- burse or make payments on an amount subject to withholding or who makes a withholdable payment [IRC section 1441(a); Treasury Regulations section 1.1441-7(a)(1)]. Withholding agents can be individuals, corporations, partnerships, trusts, or any other entity. In Private Letter Ruling (PLR) 200244017, the IRS determined that a law firm that had consulted with a foreign lawyer was a withholding agent and required to with- hold on the payment to the foreign lawyer for his work in the United States.
The rules surrounding withholding on U.S.–sourced income are complex. This article describes some of the basic general rules, but tax professionals should review the applicable statutes, regulations, and guidance before advising a client about whether a specific payment is subject to withholding and what the client must do to be compliant. IRS Publication 515, the IRS’s Withholding Agent Frequently Asked Questions page (http://bit.ly/2oIA2Fw), the IRS’s audit guide “U.S. Withholding Agent Examinations,” and Internal Revenue Manual 4.10.21 are helpful resources.
Withholding Rules
A payor of U.S.–sourced income to a nonresident alien is generally required to deduct and withhold 30% of the amount of the payment, unless a lower treaty rate applies. The with-
A withholding agent must withhold on payments to for- eign persons unless the withholding agent can “associate the payment with documentation upon which it can rely to treat the payment as made to a payee that is a U.S. person” or to an otherwise exempt payee [Treasury Regulations sec- tion 1.1441-(b)(3)]. Generally, the payee provides the with-
60
MAY 2017 / THE CPA JOURNAL