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Final 2014 Form 1042 reflects major changes including new FATCA withholding

IRS has issued final 2014 Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. The form has significant changes as compared to 2013 Form 1042, including lines and instructions to reflect the withholding rules under the Foreign Account Tax Compliance Act (FATCA) and requirements to provide increased amounts of detail with respect to gross amounts of payments to foreign persons, taxes withheld from those persons, etc.

Background. Chapter 3 of the Code, “Withholding of tax on nonresident aliens and foreign corporations” (Code Sec. 1441 through Code Sec. 1465), contains reporting and withholding rules relating to payments of certain U.S. source income (e.g., dividends on stock of U.S. companies) to non-US persons. These payments are payments from sources within the United States that constitute (a) fixed or determinable annual or periodical (FDAP) income; (b) certain gains from the disposal of timber, coal, or domestic iron ore with a retained economic interest; (c) gains relating to contingent payments received from the sale or exchange of patents, copyrights, and similar intangible property; and (d) distributions of effectively connected income by a publicly traded partnership.

Code Sec. 5000C subjects to tax, and requires that tax be withheld from, specified federal procurement payments to foreign persons.

Effective for withholdable payments made on or after July 1, 2014 (Reg. § 1.1471-2T(a)(1)), Chapter 4 of the Code (Code Sec. 1471 through Code Sec. 1474, FATCA) requires withholding agents to withhold 30% of certain payments to a foreign financial institution (FFI) unless the FFI has entered into an agreement (FFI agreement) with IRS to, among other things, report certain information with respect to U.S. accounts. Chapter 4 also imposes withholding requirements on withholding agents, with respect to certain payments made to certain non-financial foreign entities (NFFEs).

A substitute dividend payment is a payment, made to the transferor of a security in a securities lending transaction or a sale-repurchase transaction, of an amount equivalent to a dividend distribution which the owner of the transferred security is entitled to receive during the term of the transaction. (Reg. § 1.861-3(a)(6)) A parallel rule applies to substitute interest payments. (Reg. § 1.861-2(a)(7)) “Substitute payments” is a term for substitute dividend payments and substitute interest payments. (Reg. § 1.864-5(b)(2)(ii))

Every withholding agent must file an information return on Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, to report amounts paid during the preceding calendar year that are described above.

Form 1000, Ownership Certificate, is used to report interest paid and tax owed on bonds that have a tax-free covenant and that were issued before ’34 by a domestic corporation or a resident or nonresident foreign corporation.

Historically, Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, has only been used to report various items with respect to income paid to foreign persons for which Chapter 3 withholding was required and to report the Code Sec. 5000C tax due.

2014 Form 1042, and its instructions, contain many changes. IRS has recently issued 2014 Form 1042 and the instructions to that form. IRS made significant changes, including expanding the circumstances under which the form must be filed and expanding the form from one page to two pages. Here is some detail about the changes:

… Additional circumstances under which Form 1042 must be filed. The instructions to 2014 Form 1042 expand the circumstances under which the form must be filed to include: (a) reporting payments and amounts withheld under FATCA; (b) where the taxpayer files Form(s) 1042-S to report to a recipient tax withheld by the taxpayer’s withholding agent; and (c) where the taxpayer is one of several types of intermediaries making a claim for a collective refund under its respective agreement with IRS.

… Additional detailed information required. For 2013, Form 1042 contained single lines for the following: gross income reported on Forms 1042-S and 1000; total tax withheld or assumed on those forms; total net tax liability; and credit for amounts withheld by other withholding agents.

For 2014, Form 1042 contains multiple lines to show how the taxpayer arrives at the above amounts, as well as lines for those amounts themselves. For example, in arriving at the amount of gross income reported on Forms 1042 and 1000, taxpayers must break out the amount of gross income that was substitute payments.

In addition, there is a new line, Line 62d, to report gross amounts actually paid that differed from the amounts reported on Forms 1042-S and 1000.

…New Section 2, Reconciliation of payments of U.S. source FDAP income. Form 1042 contains a new section, Section 2, which is entitled “Reconciliation of Payments of U.S. Source FDAP Income.” For 2014, this section is optional. In future years, withholding agents will be required to complete this section.

This section is used by the withholding agent to reconcile the amount of U.S. source FDAP income reportable under FATCA and paid by the withholding agent during the calendar year with the total amount of U.S. source FDAP income reported on all Forms 1042-S filed by the withholding agent for the calendar year. This reconciliation has the withholding agent separating out the following categories that are added together to arrive at the amount of U.S. source FDAP income reportable under FATCA: (i) total U.S. source FDAP income required to be withheld upon under FATCA; and (ii) total U.S. source FDAP income required to be reported under FATCA but not required to be withheld upon under FATCA, broken down into six subcategories.

… New Section 3, Notional principal contract payments and other payments on derivative contracts that reference (in whole or in part) a U.S. security. Section 3 is also a new section. Parties that are dealers or traders in notional principal contracts or other derivative contracts that reference in whole or in part one or more U.S. securities, and that made payments on such contracts during the calendar year, should check the box in this section.

Early issuance of the form. IRS notes that 2014 Form 1042 shouldn’t be filed until 2015, but it is providing the form at this time solely for informational purposes in order to provide as much time as possible for withholding agents and intermediaries to implement the new FATCA requirements.

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