Are you a Withholding Agent? Increasingly Onerous Penalties Enacted
posted Jan 12, 2016 by Paul Oliveira, CPA
Budget limitations at the Internal Revenue Service are having an effect on the audit approaches and enforcement actions that it uses. Taxpayer failures related to information reporting and proper withholding of tax are attracting notable attention. This is understandable given the ability of the IRS to assess material penalties due to such failures, as well as the considerable tax revenue that may ultimately be levied on foreign taxpayers.
In light of these changes, it is very important to understand whether you might be a withholding agent and, if so, the consequences of failure to fulfill your withholding agent responsibilities. A ‘withholding agent’ is any person, natural or otherwise, that is required to withhold tax at source on a payment of US source income to a foreign person. A withholding agent is required to withhold proper amounts of tax from US withholdable payments, timely remit the amount withheld, and timely and accurately report the amount of income and tax withheld to the payee and IRS.
The most common forms that are required to be provided by a withholding agent are Forms 1042 and 1042-S. Form 1042, Annual Withholding Tax Return for US Source Income of Foreign Persons, is due by March 15th of the following year. An extension of time to file is available, although it does not extend the time to remit the tax. Form 1042-S, Foreign Person’s US Source Income Subject to Withholding, is also due to both the IRS and the payee by March 15th of the following year. Similarly, an extension can be requested to delay providing the information report to the payee, albeit for only an additional 30 days. The IRS has hinted that it may be more stringent in the granting of extensions in the future.
What are the potential consequences of a failure to file?
In general, the failure to timely and accurately file the required information returns attracts a penalty. The amount of the penalty has increased for information returns that are filed after December 31, 2015. The failure to file information returns with the IRS and the payee may result in a penalty of $260 per form (up from $100), with a maximum penalty for a calendar year of $3,193,000 (up from $1,500,000).
Additional penalties are applied when the IRS asserts that there has been an ‘Intentional Disregard’ of the rules and regulations by a withholding agent and prevails in its assertion. The IRS has the burden of proof to show that the filer was required to file an information return, knew (or should have known) of the requirement to file, and knowingly ignored the requirement. This is a facts and circumstances determination.
The amount of the penalty for intentional disregard to file Form 1042-S has increased for information returns that are filed after December 31, 2015. The penalty has increased to the greater of $530 per form (up from $250) or the 10% of the required reportable amount.
What net steps should you take?
The time to gather payment information is now. Consider any potential withholdable payments of US source income, including estimates of the amounts if final information will not be available until a later date. Evaluate historical compliance and ensure that there is a process in place to capture this information and timely file current year information returns. The costs of non-compliance can become significant very quickly.
Questions? Contact a member of our KLR Global Tax Services Group.