The IRS enforces compliance with withholding obligations by collecting the underwithheld tax from payers who fail to meet their obligations to withhold and timely pay overwithheld taxes. Assessments are increased for penalties as provided by the Code (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. 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.
In addition to imposing the underwithheld tax on a payer that fails to meet their withholding obligation, IRS will impose penalties and interest computed on the amount of the underwithheld tax and penalties. The following are the penalties that may apply, depending upon the failure of the payer.
(i) 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.
(ii) 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.
(iii) 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.
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