Tax & Accounting Blog

Information Reporting on Form 1042-S, A New Challenge for Accounts Payable – Part 9: Pay for Services Performed by an Entity Income Code

ONESOURCE August 21, 2012

Pay for services made to an entity, for the services of its employees and contractors that were provided in the United States, is also considered to be ECI. The Treasury explanations generally explain that such pay for services is covered by the Business Profits Article. For example, the Treasury explanation of Article 7 of the treaty with Ireland states that paragraph 7 of the article, which defines “profits”:

“… states the long-standing U.S.view that income earned by an enterprise from the furnishing of personal services is business profits. Thus, a consulting firm resident in one State whose employees perform services in the other State through a permanent establishment may be taxed in that other State on a net basis under Article 7, and not under Article 14 (Independent Personal Services), which applies only to individuals. The salaries of the employees would be subject to the rules of Article 15 (Dependent Personal Services).”

Because the IRS has not assigned an Income Code for pay for services provided by an organization, payers commonly record the payments under Code 50 (Other Income).

When this income is treaty-exempt (Exemption Code 04) under a Business Profits Article, the Form 1042-S is not sufficient to determine whether a tax return is required or not. A return is required for ECI with Income Code 50 but not necessarily FDAPI with Income Code 50. When the compensation is treaty-exempt, the Exemption Code no longer identifies the income as ECI (Exemption Code 01). While larger organizations have sophisticated tax advisors who advise them about their U.S.tax return filing obligations, smaller organizations providing services in the United Statesmay lack such advisors. A separate Income Code for pay for services provided by an entity (or for business profits generally) would be helpful for taxpayers and their advisors.