Depositing Withheld Taxes

This section discusses the rules for depositing income tax withheld on FDAP income. The deposit rules discussed here do not apply to the following items.

• Tax withheld on pay subject to graduated withholding as discussed earlier. (See Form 941 for the deposit rules.)
• Tax withheld on pensions and annuities subject to graduated withholding or the 10% tax on nonperiodic distributions. (See Form 945 for the deposit rules.)
• Tax withheld on a foreign partner's share of effectively connected income of a partnership. See Partnership Withholding on Effectively Connected Income, later.
• Tax withheld on dispositions of U.S. real property interests by foreign persons. See U.S. Real Property Interest, later.
• Tax withheld on household employee. See Schedule H (Form 1040), Household Employment Taxes, to report social security and Medicare taxes, and any income tax withheld, on wages paid to a nonresident alien household employee.

When Deposits Are Required

A deposit required for any period occurring in one calendar year must be made separately from a deposit for any period occurring in another calendar year. A deposit of this tax must be made separately from a deposit of any other type of tax.

The amount of tax you are required to withhold determines the frequency of your deposits. The following rules show how often deposits must be made.

1. If at the end of a calendar year the total amount of undeposited taxes is less than $200, you may either deposit the entire amount or remit it with Form 1042 by the due date of your Form 1042.
2. If at the end of any month the total amount of undeposited taxes is $200 or more but less than $2,000, you must deposit the taxes within 15 days after the end of the month. If you made a deposit of $2,000 or more during the month (except December) under rule 3 below, carry over any end of the month balance of less than $2,000 to the next month. If you made a deposit of $2,000 or more during December, any end of December balance of less than $2,000 should be paid directly to the IRS along with your Form 1042 by the due date.
3. If at the end of any quarter-monthly period the total amount of undeposited taxes is $2,000 or more, you must deposit the taxes within 3 banking days after the end of the quarter-monthly period. (A quarter-monthly period ends on the 7th, 15th, 22nd, and last day of the month.) In figuring banking days, exclude any local holidays observed by authorized financial institutions, as well as Saturdays, Sundays, and legal holidays.

You are considered to meet the deposit requirements in (3) if:

1. You deposit at least 90% of the actual tax liability for the deposit period, and
2. You deposit any underpayment with the first deposit that you must make after the 15th day of the following month, if the quarter-monthly period is in a month other than December. You must deposit any underpayment of $200 or more for a quarter-monthly period that occurs during December by January 31.

Electronic deposit requirement. You must use the Electronic Federal Tax Payment System (EFTPS) to make electronic deposits of all depository tax liabilities you incur after 2001, if you meet either of the following conditions.

• You had to make electronic deposits in 2001.
• You deposited more than $200,000 in federal depository taxes in 2000.

If you do not meet these conditions, you may choose to make electronic deposits.

To participate in EFTPS, you must first enroll. To receive an enrollment form, call 1-800-945-8400 or 1-800-555-4477.

Federal tax deposit coupons. If you do not make electronic deposits, you must deposit the income tax withheld on fixed or determinable annual or periodic income using Form 8109, Federal Tax Deposit Coupon, according to the instructions provided with the form. If you do not have your coupons when a deposit is due, contact your local IRS office.

To eliminate possible late payment penalty charges, be prepared to show that the payment was mailed by the second day before the due date.

Deposits made by foreign corporations. If you use a Form 8109, show the "Amount of Deposit" in U.S. dollars. Send the completed coupon with a bank draft in U.S. dollars to: Financial Agent Federal Tax Deposit Processing P.O. Box 970030 St. Louis, MO 63197.

Obtaining coupon book. A preinscribed book of Federal Tax Deposit Coupons (Form 8109) automatically will be sent to you after you apply for an employer identification number. Apply by completing Form SS-4, available from the IRS. If you have not received the coupon book, you should contact your local IRS office.

Record of deposit. Before making a deposit, enter the amount of payment on the coupon and in your records. The coupon will not be returned to you, but will be used to credit your tax account as identified by your employer identification number.

Penalty for failure to make deposits on time. If you fail to make a required deposit within the time prescribed, a penalty is imposed on the underpayment (the excess of the required deposit over any actual timely deposit for a period). You can avoid the penalty if you can show that the failure to deposit was for reasonable cause and not because of willful neglect. Also, the IRS may waive the penalty if certain requirements are met.

Penalty rate. If the deposit is:

• 1 to 5 days late, the penalty is 2% of the underpayment,
• 6 to 15 days late, the penalty is 5%, or
• 16 or more days late, the penalty is 10%.

However, if the deposit is not made within 10 days after the IRS issues the first notice demanding payment, the penalty is 15%.

If you owe a penalty for failing to deposit tax for more than one deposit period, and you make a deposit, your deposit is applied to the most recent period to which the deposit relates. Generally, if the deposit was required to be made before 2002, your deposit is applied to the oldest period first. You can designate the deposit period or periods to which your deposit is to be applied. You can make this designation only during a 90 day period that begins on the date of the penalty notice. The notice contains instructions on how to make this designation.

Adjustment for Overwithholding

What to do if you overwithheld tax depends on when you discover the overwithholding.

Overwithholding discovered by March 15 of following calendar year. If you discover that you overwithheld tax by March 15 of the following calendar year, you may use the undeposited amount of tax to make any necessary adjustments between you and the recipient of the income. However, if the undeposited amount is not enough to make any adjustments, or if you discover the overwithholding after the entire amount of tax has been deposited, you can use either the reimbursement or the set-off procedure to adjust the overwithholding.

If March 15 is a Saturday, Sunday, or legal holiday, the next business day is the final date for these actions.

Reimbursement procedure. Under the reimbursement procedure, you repay the beneficial owner or payee the amount overwithheld. You use your own funds for this repayment. You must make the repayment by March 15 of the year after the calendar year in which the amount was overwithheld. For example, if you overwithheld tax in 2002, you must repay the beneficial owner by March 17, 2003 (March 15, 2003 is a Saturday).

You may reimburse yourself by reducing any subsequent deposits you make before the end of the year after the calendar year in which the amount was overwithheld. The reduction cannot be more than the amount you actually repaid.

If you will reduce a deposit due in that later year, you must show the total tax withheld and the amount actually repaid on a timely filed (not including extensions) Form 1042-S for the calendar year in which the amount was overwithheld. You must state on a timely filed (not including extensions) Form 1042 that you are claiming a credit.

Example. James Smith is a resident of the United Kingdom. In December 2002, domestic corporation M paid a dividend of $100 to James, at which time M corporation withheld $30 and paid the balance of $70 to him. On February 11, 2003, James gave M Corporation a valid Form W-8BEN. He advises M Corporation that under the income tax convention with the United Kingdom, only $15 tax should have been withheld from the dividend and requests repayment of the $15 overwithheld. Although M Corporation had already deposited the $30, the corporation repaid James $15 before the end of February.

During 2002, M Corporation made no other payments from which tax had to be withheld. On its timely filed 2002 Form 1042, M Corporation reports $15 as its total tax liability and $30 as its total deposits. M Corporation requests that the $15 overpayment be credited to its 2003 Form 1042 rather than refunded.

The Form 1042-S that M Corporation files for the dividend paid to James in 2002 must show a tax withheld of $30 in box 7 and $15 as an amount repaid in box 8.

In June 2003, M Corporation made payments from which it withheld tax of $200. On July 15, 2003, M Corporation deposited $185, that is, $200 less the $15 credit claimed on its Form 1042 for 2002. M Corporation timely filed its Form 1042 for 2003, showing tax liability of $200, $185 deposited, and $15 credit from 2002.

Set-off procedure. Under the set-off procedure, you repay the beneficial owner or payee the amount overwithheld by reducing the amount you would have been required to withhold on later payments you make to that person. These later payments must be made before the earlier of:

• The date you actually file Form 1042-S for the calendar year in which the amount was overwithheld, or
• March 15 of the year after the calendar year in which the amount was overwithheld.

On Form 1042 and Form 1042-S for the calendar year in which the amount was overwithheld, show the reduced amount as the amount required to be withheld.

Overwithholding discovered at a later date. If you discover after March 15 of the following calendar year that you overwithheld tax for the prior year, do not adjust the amount of tax reported on Forms 1042-S (and Form 1042) or on any deposit or payment for that prior year. Do not repay the beneficial owner or payee the amount overwithheld.

In this situation, the recipient will have to file a U.S. income tax return (Form 1040NR or Form 1040NR-EZ or Form 1120-F) or, if a tax return has already been filed, a claim for refund (amended Form 1040NR or 1120-F) to recover the amount overwithheld.

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