ParenteBeard Tax Alert

IRS to Assert Penalties for
Information Reporting Filing Failures

June 2011

This summer the IRS intends to begin automatically asserting penalties for information reporting filing failures when withholding agents issue incorrect statements to foreign recipients for fixed or determinable annual or periodical income.  A brief reminder of the withholding tax rules is set forth below.

There are two sets of withholding tax rules that apply to payments made by a “U.S. person”. The term “U.S. person” is all-inclusive because it refers to any legal entity organized or incorporated in the United States, such as a U.S. corporation, a U.S. partnership, a U.S. estate or a U.S. trust.  A U.S. Person is also a U.S. citizen or a foreign national who is a U.S. tax resident. The first set of rules relates to “Back-Up Withholding” and the second set of rules relates to “Foreign Withholding”.

Back-Up Withholding

These rules apply to payments of a) interest, b) dividends, c) rent, d) royalties, e) salaries, f) wages, g) premiums, h) annuities, i) compensations, j) remunerations, k)  amounts reported by brokers, l) and/or other fixed or determinable gains, profits and income (e.g., “Identified Payments”).

The back-up withholding tax rules require every U.S. person to know to whom he/she/it is making an Identified Payment. To avoid the back-up withholding tax, the recipient must provide the U.S. Payor with either a Form W-9 or a Form in the W-8 series. If a U.S. Payor makes an Identified Payment to a recipient who has NOT furnished either a Form W-9 or a Form in the W-8 series, the U.S. Payor is required to withhold U.S. tax under the back-up withholding rules.  Under these rules, tax at a 28 percent rate is withheld from payments to a U.S. recipient, and tax at a 30 percent rate is withheld from payments to a foreign recipient. If a U.S. Payor makes an Identified Payment and does not collect the back-up withholding taxes, the U.S. Payor becomes liable for the taxes that should have been withheld. 

Given the IRS’ announcement that it intends to look at withholding taxes, ParenteBeard recommends that U.S. Payors consider obtaining any missing Forms W-9 or Forms  in the W-8 series from recipients who received or receive an Identified Payment.

Foreign Withholding

In addition to the back-up withholding rules, U.S. persons are also generally required to withhold U.S. tax at a 30 percent rate when they make payments of U.S. source fixed or determinable annual or periodical, e.g., FDAP Income to any foreign person.  A foreign person is any individual or legal entity that is not a U.S. person.  FDAP income generally consists of a) interest, b) dividends, c) rent, d) royalties, e) salaries, f) wages, g) premiums, h) annuities, i) compensations, j) remunerations, k) and/or other gains, profits and income. 

In general, in order for the U.S. Payor to use a lower withholding tax rate that is provided by an applicable income tax treaty, the foreign recipient must provide a Form in the W-8 series that includes the foreign recipient’s U.S. tax identification number (“TIN”).   If there is no U.S. TIN on the form in the W-8 series, the U.S. Payor is required to withhold U.S. tax at a 30 percent rate from the payments of U.S. source FDAP Income made to the foreign recipient, even if the foreign recipient is related or connected to the U.S. Payor. The income paid to a foreign recipient and the withholding taxes subtracted from payments to foreign recipients are reported on forms in the 1042 series.   If the U.S. Payor did not collect the correct amount of withholding taxes from its payments to foreign recipients, the U.S. Payor becomes liable for the taxes that should have been withheld.  

Given the IRS’ announcement that it intends to look at withholding taxes, ParenteBeard recommends that U.S. Payors consider obtaining any missing Forms in the W-8 series from foreign recipients receiving U.S. source FDAP Income and checking that all such forms have the foreign recipient’s U.S. TIN.  If the form is missing a U.S. TIN, ParenteBeard recommends that the U.S. Payor consider obtaining a corrected form in the W-8 series from the foreign recipient.   

The informal comments presented above should not be construed as constituting tax advice applicable to any specific taxpayer because each taxpayer’s facts are different. 

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice mentioned in the presentation or contained in this alert is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transactions or matters addressed herein. 

ParenteBeard can help you address your Back-Up Withholding or Foreign Withholding on FDAP Income questions. Please contact the following members of the ParenteBeard International Tax Services Group or your local tax advisor to discuss the application of these rules to your situation.

Jamie Robbins, Partner
Practice Leader, International Tax Services
James.Robbins@ParenteBeard.com
212.736.8734

Rob Arthur, Principal
International Tax Services
Rob.Arthur@ParenteBeard.com
215.557.2285