Are you, or is your company, making payments to foreign persons? Are you maintaining the proper paperwork for U.S. withholding purposes?

Generally, a foreign person is subject to U.S. withholding tax on its U.S. source income unless a reduced rate or exemption applies in the tax treaty between the foreign person's county of residence and the United States. A foreign person is generally defined as a nonresident alien individual, foreign corporation, foreign partnership, foreign trust, foreign estate, or foreign branch of a U.S. corporation or partnership. Types of income subject to this tax withholding include, but are not limited to, interest, dividends, rent, royalties, and compensation.

Payor Responsibilities

For each foreign payee, the U.S. payor must obtain a Form W-8 to certify the payee's foreign status. A Form W-8 must be provided to the payor by the payee in order to support a tax withholding rate of less than 30%. In many situations, the payor will be asked by the payee which W-8 form should be completed. Currently, the most commonly used W-8 forms are Form W-8BEN and Form W-8ECI.
 

Form W-8BEN is used to certify that the payee is a foreign person, and that they are claiming a treaty benefit for a reduced or zero tax rate. Form W-8ECI is used to certify that the foreign person has effectively connected income (ECI) with a U.S. trade or business, and is filing a U.S. tax return. The payor is not required to withhold U.S. income tax from payments to persons with U.S. ECI.

If neither form is obtained from the payee, the payor should withhold at the 30% rate.  If the payor has reason to believe the payee is a foreign person, and has provided a false W-8 form, the payor should also withhold tax at the 30% rate.

The withholding agent must report the payment and withholding tax to the IRS on Form 1042 and Form 1042-S. Payments will need to be reported on Form 1042 and Form 1042-S-even if no amount is withheld due to treaty based position.

Implementation of FATCA Rules

Significant changes to the Form W-8 series are imminent due to implementation of the Foreign Account Tax Compliance Act of 2010 (FATCA). Based on the recently released 2013 draft forms, the updated Form W-8BEN is split into two separate forms: a Form W-8BEN for individuals and a six-page long Form W-8BEN-E for entities. Final versions of the forms and instructions are expected sometime in 2014.

The IRS allows the payor to rely on a pre-FATCA form W-8 for payments made prior to January 1, 2017. In light of these upcoming changes, payors should consider obtaining a signed Form W-8 before the newer and more complex rules and forms take effect.

If you need assistance with compliance of payments to foreign persons, please contact Liting Mitchell, Senior Tax Manager at Berntson Porter, at 425-289-7625 or lmitchell@bpcpa.com.