IRS published new 1042-S instructions

IRS published new 1042-S instructions

On March 3, 2023 the Internal Revenue Service (IRS) published new 1042-S instructions. The instructions are for the 2023 version of Form 1042-S, used for reporting Foreign (non-resident) Person’s US Source Income Subject to Withholding, for the tax year 2023. Withholding agents file Form 1042-S to report amounts paid to foreign persons including but not limited to; salaries, interest, dividends, premiums, pensions, scholarships, and grants) from sources within the U.S. during the preceding calendar year that are subject to withholding.

The key updates in the instructions relate to Chapter 3 and Chapter 4 status and exemption codes. Additionally, new income codes have been introduced concerning regulations on trading interests in publicly traded partnerships (PTP), which became effective on January 1, 2023. The Foreign Account Tax Compliance Act (FATCA) is significantly impacted by these changes, affecting Financial Institutions with 1042-S reporting responsibilities.

This article has been updated with the revision to the 2023 Instructions for Form 1042-S, released by the IRS on the August 17.

Summary of 1042-S Form and Instruction Changes

The 2023 Form 1042-S and 2023 Form 1042-S instructions contain a lot of useful and valuable information however they are quite extensive at 42 pages long. We have summarized below the new changes for this year:

Income code 57 was added to the 2022 Form 1042-S:

• For use by brokers (starting for 2023) to report amounts realized and related withholding from transfers of PTP interests for purposes of section 1446(f) that are subject to reporting on Form 1042-S under Regulations section 1.1461-1(c)(2)(i).

New income code 58 is added starting for 2023:

• For nominees to report on Form 1042-S when they are unable to determine the characterization of income associated with a PTP distribution.

• Therefore, they apply regulations section 1.1446-4(d)(1) to withhold on the distribution in the absence of a qualified notice specifying the income attributable to the distribution.

New chapter 3 status code 39 (Disclosing QI) is added starting for 2023:

• To be used when a broker, PTP, or nominee makes a payment of an amount realized or PTP distribution to a QI acting as a disclosing QI.

• The disclosing QI's information should be reported in boxes 15a through 15i of the form.

Revised reporting with respect to territory financial institutions.

• The chapter 3 status codes for withholding agents making payments subject to chapter 3 withholding to territory financial institutions (FIs) have been removed.

• Chapter 3 status codes 03 and 04 for territory FIs treated as (or not treated as) U.S. persons

• Chapter 3 exemption code 09 for payments made to territory FIs treated as U.S. persons.
• For these cases, withholding agents should use the chapter 3 status and exemption codes applicable to U.S. branches, and should continue to report using the applicable chapter 4 status codes for a territory FI for chapter 4 purposes.

Limitation on benefits (LOB) code 12.

•  This code was added to the 2022 Form 1042-S to report the absence of an LOB article in the applicable tax treaty, though this scenario is rare.

For more information refer to the instructions attached to Form 1042-S.

Revision to the 2023 Instructions for Form 1042-S

On August 17, the IRS released a revision to the 2023 Instructions for Form 1042-S(irs.gov). Two Specific revisions elaborating on IRS tips and notes to the instruction were made relating to  Publicly Traded Partnerships (PTPs).

• The first update is related to when a U.S. partner is treated as a foreign partner for 1446 (a and f) a form 1042-S may be sent to that U.S. person, if using a 1042-S a 1099 must also be filed but without the 1446 withholding that was included in the1042-S. The update clarified further the 1099 requirements.  The IRS revision for this is:
  • Page 12, the 2nd tip under Publicly Traded Partnerships (Sections 1446(a) and (f) Withholding Tax) should read as follows:

When a partner that is a U.S. person was treated as a foreign partner for purposes of withholding under section 1446(a) or (f) (including an allocation of a payment to the person made on a withholding statement), a Form 1042-S may be used to report the payment (and withholding) with respect to the U.S. person. In such a case, the applicable form 1099 must also be filed and furnished when otherwise required of the withholding agent with respect to the payment but should not report the withholding that was applied under section 1446(a) or (f). For further information on reporting requirements for Form 1099, see the General Instructions for Certain Information Returns.

• The second update elaborates further on an existing note.  The elaboration adds an exception of pooled reporting to when one reports a separate 1042-S  to each PTP that makes a distribution. The revision also notes a PTP may report on one qualified notice 1446(f) withholding and other chapter 3 and 4 withholding but even if on one notice separate 1042-S forms need to be issued to the payee for the different withholding.  The IRS revision is:
  • Page 33, the note under Boxes 16a Through 16e, Payer's Name, TIN, GIIN, and Status Code should read as follows:

You must issue a separate Form 1042-S to complete boxes 16a through 16e for each PTP that makes a distribution reportable in any of the above-noted income codes except when you report a PTP distribution paid to a QI using reporting pools or are a QI reporting on Forms 1042-S in reporting pools with respect to a distribution. This exception also applies for purposes of the reporting of PTP distributions described in Publicly Traded Partnerships (Sections 1446(a) and (f) Withholding Tax).

A PTP may report the same amount of a PTP distribution on a qualified notice as subject to both section 1446(f) withholding and other chapter 3 or 4 withholding (such as under section 1446(a)). See Regulations sections 1.1446-4(b)(4) and 1.1446(f)-4(c)(2)(iii). In this case, you must report the same amount on separate Forms 1042-S, with the appropriate income code and associated amount of withholding included on each form. Therefore, the total amounts reported on Forms 1042-S in Box 1 (income codes) resulting from the distribution may, in some cases, exceed the actual amount of the distribution.

How will the new 1042-S form and instructions impact financial institutions?

Financial institutions acting as withholding agents must file 1042-S, by the 15th of March for the following calendar year in which the income subject to reporting was paid. If the institution is a filer of over 250 1042-S forms, they will need to file these electronically. It is crucial for these institutions to ensure that the correct Form 1042-S is used for income paid during that year. For example, the 2023 Form 1042-S must be used to report income paid in 2023.

We have also seen the Form 1042-S penalties continue to increase. If the wrong Form 1042-S is filed or the 1042-S is filed late, the withholding agent may be liable for penalties and interest unless you can show that the failure to file or pay was due to reasonable cause and not wilful neglect.

To ensure accurate Form 1042-S reporting and minimize tax and penalty exposure, the TAINA platform, with the help of Big Four, is being updated to align with the recent changes. This ensures the provided data during validation, API, and export files complies and allows our clients to produce accurate form 1042-S reporting thus minimizing unwanted scrutiny from the IRS.

If you have any questions about the 1042-S instruction updates and would like to have a chat about them, please reach out to us.

If you would like to see how the TAINA FATCA, CRS and QI Compliance Platform can add value to your business, request a demo today.