The IRS enforces compliance with withholding obligations by collecting the under-withheld tax from payers who fail to meet their obligations to withhold and timely pay over withheld taxes. Assessments are increased for penalties as provided by the Code1 (and explained in the instructions for the various forms) and for interest computed on the taxes and penalties. Penalties may also be imposed for failure to comply with reporting obligations with IRS and the recipients of the income.2 IRS will figure the amounts of penalties and interest due. A payer may be able to abate the penalty by showing that the failure was for reasonable cause and not because of willful neglect.
- Failure to Meet Withholding Obligations.
In addition to imposing the under-withheld tax on a payer who fails to meet their withholding obligation, IRS will impose penalties and interest computed on the amount of the under-withheld tax and penalties. The following are the penalties that may apply, depending upon the failure of the payer.
- Penalty for Late Deposit.
The schedule for making Form 1042 deposits is described in IRS Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities. If a payer fails to make a required deposit within the time prescribed, the IRS will impose a penalty on the underpayment, that is, the excess of the required deposit over any actual timely deposit for the period.
The penalty rate is based on the number of days that the deposit is late, as follows:
- 1 to 5 days late, 2 percent,
- 6 to 15 days late, 5 percent, or
- 16 or more days late, 10 percent.
If the late deposit is not made within 10 days after IRS issues the first notice demanding payment, the penalty is 15 percent.
- Penalty for Paying Late.
The penalty for late payment is ½ of one percent of the tax not paid by the original due date of a Form 1042 tax return for each month or part of a month that the tax remains unpaid. The penalty cannot exceed 25 percent of the tax due.
- Trust Fund Taxes.
When taxes are withheld from payments made to the owner of the income, the taxes withheld are credited to the account of the payee. These withheld taxes are called “trust fund taxes” because they are considered to be a trust from the time that they are withheld from the payment until the time that they are deposited with the government.
Section 6672 of the Code and the regulations under that section impose liability on responsible parties for the willful failure to withhold and pay over the trust fund taxes. The scope of section 6672 is broad enough to be applied to withholding of tax at source under Chapter 3. Because taxes may not be collected by IRS twice, a payer that can show that the payee paid the tax or owed no tax may request a refund of the under withheld tax they paid.
The IRS will charge interest on any tax not paid by the original due date until the tax is paid. The interest will accrue even if an extension has been granted. Interest is figured at a rate determined under section 6621.
- Penalty for Late Deposit.
- Failure to Report Timely.
In addition to the failure to withhold, IRS imposes penalties for the failure to report income timely. Section 1461 of the Code and the regulations under that section provide the filing obligations of payers making payments to non-U.S. persons. The following penalties may be imposed for failure to comply with the Form 1042 and 1042-S requirements:
- Late Filing of Correct Form 1042-S.
The amount of the penalty for submitting Forms 1042-S is based on when the forms are submitted and the number of forms submitted. The penalty is computed as follows:
- $30 per Form 1042-S if correctly filed within 30 days of March 15. The maximum penalty is $250,000 per year ($75,000 for a small business).
- $60 per Form 1042-S if correctly filed more than 30 days after March 15 but by August 1. The maximum penalty is $500,000 per year ($200,000 for a small business).
- $100 per Form 1042-S if correctly filed after August 1 or correct Forms 1042-S are not filed. The maximum penalty is $1,500,000 per year ($500,000 for a small business).
A small business is defined as a business with average annual gross receipts of $5 million or less for the three most recent tax years (or the period of existence of the business if shorter) ending before the calendar year in which the Forms 1042-S are due.
If a withholding agent does not intentionally file required Forms 1042-S, the minimum penalty is $100 per form or, if greater, 10 percent of the total amount of the items that must be reported, with no maximum penalty.
- Failure to Furnish Correct Form 1042-S for Recipient.
If a payer fails to provide statements to recipients and cannot show reasonable cause, a penalty of up to $100 may be imposed for each failure to provide a Form 1042-S when due. The penalty also may be imposed for failure to include all required information or for furnishing incorrect information on Form 1042-S.
The maximum penalty is $1,500,000 for all failures to furnish correct recipient statements during a calendar year. If the payer provides the correct statement on or before August 1, reduced penalties similar to those for failing to file a correct Form 1042-S with IRS described above may be imposed.
However, if the withholding agent is determined to have intentionally disregarded the requirement to report correct information, each $100 penalty is increased to $250 or, if greater, 10 percent of the total amount of items required to be reported, with no maximum penalty.
- Failure to File Forms 1042-S Electronically.
A payer with 250 or more Forms 1042-S must file the IRS forms electronically through IRS’s Filing Information Returns Electronically (FIRE) System. A payer required to file electronically that fails to do so may be subject to a $100 per return penalty unless the payer has an approved waiver (applied for on a Form 8508) or establishes reasonable cause for the failure. The penalty applies separately to original returns and amended returns.
- Late Filing of Form 1042.
The penalty for not filing Form 1042 when due (including extensions) is 5 percent of the unpaid tax for each month or part of a month that the return is late, up to a maximum of 25 percent of the unpaid tax.
- Late Filing of Correct Form 1042-S.
1Section 6651 (failure to file or pay) and section 6656 (failure to timely deposit). IRS may also impose accuracy-related penalties on underpayments for negligence under section 6662, penalties for fraud under section 6663, and criminal penalties under section 7201-7216.
2Section 6721 (failure to file correct information returns), section 6722 (failure to file correct payee statements), and section 6723 (failure to comply with other information reporting requirements)