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 2003, you must repay the beneficial owner by March 15, 2004.

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 2003, 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, 2004, 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 2003, M Corporation made no other payments from which tax had to be withheld. On its timely filed 2003 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 2004 Form 1042 rather than refunded.

The Form 1042-S that M Corporation files for the dividend paid to James in 2003 must show a tax withheld of $30 in box 7 and $15 as an amount repaid in box 8.

In June 2004, M Corporation made payments from which it withheld tax of $200. On July 15, 2004, M Corporation deposited $185, that is, $200 less the $15 credit claimed on its Form 1042 for 2003. M Corporation timely filed its Form 1042 for 2004, showing tax liability of $200, $185 deposited, and $15 credit from 2003.

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.

Returns Required

Every withholding agent, whether U.S. or foreign, must file Forms 1042 and 1042-S to report payments of amounts subject to NRA withholding unless an exception applies. Do not use Forms 1042 and 1042-S to report tax withheld on the following:

• Wages or salaries subject to graduated income tax withholding (see Wages Paid to Employees - Graduated Withholding, earlier under Pay for Personal Services Performed),
• Any portion of a U.S. or foreign partnership's effectively connected taxable income allocable to a foreign partner (see Partnership Withholding on Effectively Connected Income, later),
• Dispositions of U.S. real property interests by foreign persons (see U.S. Real Property Interest, later),
• Pensions, annuities, and certain other deferred income reported on Form 945, and
• Income, social security, and Medicare taxes withheld on wages paid to a household employee reported on Schedule H (Form 1040).

The Forms 1042 and 1042-S must be filed by March 15 of the year following the calendar year in which the income subject to reporting was paid. If March 15 falls on a Saturday, Sunday, or legal holiday, the due date is the next business day.

Form 1042. Every U.S. and foreign withholding agent that is required to file a Form 1042-S must also file an annual return on Form 1042. You must file Form 1042 even if you were not required to withhold any income tax.

You must file Form 1042 with Internal Revenue Service Center Philadelphia, PA 19255.

Form 1042-S. Every U.S. and foreign withholding agent must file a Form 1042-S for amounts subject to NRA withholding unless an exception applies. The form can be filed magnetically, electronically, or on paper. A separate Form 1042-S is required for each recipient of income to whom you made payments during the preceding calendar year regardless of whether you withheld or were required to withhold tax. You must use a separate Form 1042-S for each type of income that you paid to the same recipient. See Statements to recipients, later.

You must furnish a Form 1042-S for each recipient even if you did not withhold tax because you repaid the tax withheld to the recipient or because the income payment was exempt from tax under the Internal Revenue Code or under a U.S. income tax treaty.

You must get prior annual approval to use a substitute Form 1042-S unless it meets the requirements listed in Publication 1179, Rules and Specifications for Private Printing of Substitute Forms 1096, 1098, 1099, 5498, and W-2G and Form 1042-S. Get Publication 1179 for more information.

Joint owners. If all the owners provide documentation that permits them to receive the same reduced rate of withholding (for example, under an income tax treaty) you should apply the reduced rate of withholding. You are required, however, to report the payment on one Form 1042-S to the person whose status you rely upon to determine the withholding rate. If, however, any one of the owners requests its own Form 1042-S, you must furnish Form 1042-S to the person who requests it. If more than one Form 1042-S is issued for a single payment, the total amount paid and tax withheld reported on all Forms 1042-S cannot exceed the total amounts paid to joint owners.

Magnetic media reporting. Withholding agents or their agents generally must use magnetic or electronic media to file 250 or more Forms 1042-S with the IRS. You are encouraged to file electronically or magnetically even if you are not required to.

A completed Form 4419, Application for Filing Information Returns Magnetically or Electronically, should be filed with the Martinsburg Computing Center at least 30 days before the due date of the return. Returns may not be filed magnetically or electronically until the application has been approved by the IRS.

For information and instructions on filing Forms 1042-S on magnetic media, get Publication 1187, Specifications for Filing Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding Magnetically/ Electronically.

Form 1042-T. If Form 1042-S is filed on paper, it must be filed with Form 1042-T. You may need to file more than one Form 1042-T. See the instructions for that form for more information.

Deposit interest paid to alien individuals who are residents of Canada. If you pay deposit interest of $10 or more to a nonresident alien individual who resides in Canada and is not a U.S. citizen, you may have to report it on Form 1042-S. This reporting requirement generally applies to interest that a) is on a deposit maintained at a bank's office in the United States, and b) is not effectively connected with a trade or business within the United States. However, this reporting requirement does not apply to interest paid on certain bearer certificates of deposit as described in section 1.6049-8(b) of the regulations if you pay that interest outside the United States.

How to report. Although you only have to report on Form 1042-S the deposit interest paid to residents of Canada who are not U.S. citizens, you can comply by reporting payments to all foreign persons receiving bank deposit interest, if that way is easier for you.

Determining residency. You determine whether a payee is a Canadian resident based on the permanent residence address required to be provided on the Form W-8BEN. If you have actual knowledge that the payee is a U.S. person, you must report the payment on Form 1099-INT.

Statements to recipients. You must furnish a statement to each recipient for whom you are filing a Form 1042-S (or magnetic media report) by the due date for filing Forms 1042 and 1042-S with the IRS. You may use a copy of the official Form 1042-S for this purpose. Or, you may provide recipients with the information together with, or on, other (commercial) statements or notices. These statements must clearly identify the type of income (as described on the official form), the amount of tax withheld, the withholding rate (including 0% if exempt), and the country involved. You may include more than one type of income on the copies of the Form 1042-S that you provide to the recipient of the income. You may not, however, include more than one income line on the copy of the form filed with the IRS.

Extension of time to file. You may request an extension of time to file Form 1042 by filing Form 2758, Application for Extension of Time to File Certain Excise, Income, Information, and Other Returns. You may request an extension of time to file Form 1042-S by filing Form 8809, Request for Extension of Time to File Information Returns. You should send Forms 2758 and 8809 far enough in advance of the due date of Forms 1042 and 1042-S to allow the IRS time to consider your application and to reply before the due date of the return.

Penalties. The penalty for not filing Form 1042 when due (including extensions) is usually 5% of the unpaid tax for each month or part of a month the return is late, but not more than 25% of the unpaid tax.

A penalty may be imposed for failure to file Form 1042-S when due (including extensions) or for failure to provide complete and correct information. The amount of the penalty depends on when you file a correct Form 1042-S. The penalty for each Form 1042-S is:

• $15 if you file a correct form within 30 days, with a maximum penalty of $75,000 per year ($25,000 for a small business),
• $30 if you file after 30 days but before August 2, with a maximum penalty of $150,000 ($50,000 for a small business), or
• $50 if you file after August 1 or do not file a correct form, with a maximum penalty of $250,000 per year ($100,000 for a small business).

A small business is a business that has average annual gross receipts of not more than $5 million for the most recent 3 tax years (or for the period of its existence, if shorter) ending before the calendar year in which the Forms 1042-S are due.

If you fail to provide a complete and correct statement to each recipient, a penalty of $50 for each failure may be imposed. The maximum penalty is $100,000 per year. If you intentionally disregard the requirement to report correct information, the penalty for each Form 1042-S (or statement to recipient) is the greater of $100 or 10% of the total amount of the items that must be reported, with no maximum penalty.

Failure to file on magnetic media. If you are required to file on magnetic media but you fail to do so, and you do not have an approved waiver, you may be subject to a penalty of $50 per form for failure to file Form 1042-S on magnetic media unless you show reasonable cause. The penalty applies separately to original and corrected returns.

Partnership Withholding on Effectively Connected Income

A partnership (foreign or domestic) that has income effectively connected with a U.S. trade or business (or income treated as effectively connected) must pay a withholding tax on the effectively connected taxable income that is allocable to its foreign partners. A publicly traded partnership must withhold tax on actual distributions of effectively connected income, unless it chooses to withhold under these rules. See Publicly Traded Partnerships, later.

This withholding tax does not apply to income that is not effectively connected with the partnership's U.S. trade or business. That income is subject to NRA withholding tax, as discussed earlier in this publication.

Who Must Withhold

The partnership, or a withholding agent for the partnership, must pay the withholding tax. A partnership that must pay the withholding tax but fails to do so, may be liable for the payment of the tax and any penalties and interest.

Foreign Partner

The partnership must determine whether a partner is a foreign partner. A foreign partner can be a nonresident alien individual, foreign corporation, foreign partnership, or foreign estate or trust.

A partnership may rely on a partner's certification of nonforeign status and assume that a partner is not a foreign partner if the partner provides a certification to the partnership that:

1. States that the partner is not a foreign person,
2. Gives the partner's name, U.S. taxpayer identification number, and address,
3. States that the partner will notify the partnership within 60 days of a change to foreign status, and
4. Is signed under penalties of perjury.

Sample certifications are contained in section 5.04 of Revenue Procedure 89-31, in Cumulative Bulletin 1989-1.

The partnership must keep the certification 5 years after the last tax year in which the partnership relied on it.

Unless the partnership knows that the certification is incorrect, it may rely on it until one of the following happens.

1. The third year after the partnership's tax year in which the certification was made ends.
2. The partner notifies the partnership that it has become a foreign partner.
3. The partnership learns that the partner is a foreign partner.

Widely held and publicly traded partnerships. A partnership with more than 200 partners or a publicly traded partnership may rely on statements received on Form W-9 in lieu of the above certification. It may also rely on a certification from a nominee that a partner owning a partnership interest through the nominee is not a foreign partner. In this situation, the nominee may rely on a partner's certification of nonforeign status as described earlier, or it may rely on Form W-9.

Amount of Withholding Tax

The amount a partnership must withhold is based on its effectively connected taxable income that is allocable to its foreign partners for the partnership's tax year.

The foreign partner's distributive share of the partnership's gross effectively connected income is reduced by the partner's distributive share of partnership deductions for the year. For information on effectively connected income and how to figure a partner's distributive share of income and deductions, see the Instructions for Forms 8804, 8805, and 8813.

A partnership must make installment payments of withholding tax on its foreign partners' share of effectively connected taxable income whether or not distributions are made during the partnership's tax year.

Tax rate. The withholding tax rate on a partner's share of effectively connected income is 35% for a partner taxed as a corporation and 38.6% for all other partners, such as individuals, partnerships, trusts, and estates.

Amount of installment payment. The amount of a partnership's installment payment is the sum of the installment payments for each of its foreign partners. The amount of each foreign partner's installment payment of withholding tax can be figured by using the worksheet in the Instructions for Forms 8804, 8805, and 8813.

Date payments are due. Payments of withholding tax must be made during the partnership's tax year in which the effectively connected taxable income is derived. A partnership must pay the IRS a portion of the annual withholding tax for its foreign partners by the 15th day of the 4th, 6th, 9th, and 12th months of its tax year for U.S. income tax purposes. Any additional amounts due are to be paid with Form 8804, the annual partnership withholding tax return.

A foreign partner's share of withholding tax paid by a partnership is treated as distributed to the partner on the earliest of:

1. The day on which the tax was paid by the partnership,
2. The last day of the partnership's tax year for which the tax was paid, or
3. The last day on which the partner owned an interest in the partnership during that year.

Real property gains. If a domestic partnership disposes of a U.S. real property interest, the gain is treated as effectively connected income and the partnership or withholding agent must withhold following the rules discussed here. A domestic partnership's compliance with these rules satisfies the requirements for withholding on the disposition of U.S. real property interests (discussed later). This also applies to publicly traded partnerships that elect to withhold based on effectively connected income instead of on actual distributions as discussed later.

Reporting and Paying the Tax

Three forms are required for reporting and paying over tax withheld on effectively connected income allocable to foreign partners.

Form 8804, Annual Return for Partnership Withholding Tax (Section 1446). The withholding tax liability of the partnership for its tax year is reported on Form 8804. Form 8804 is also a transmittal form for Forms 8805.

Any additional withholding tax owed for the partnership's tax year is paid (in U.S. currency) with Form 8804. A Form 8805 for each foreign partner must be attached to Form 8804, whether or not any withholding tax was paid.

File Form 8804 by the 15th day of the 4th month after the close of the partnership's tax year. However, a partnership made up of all nonresident alien partners has until the 15th day of the 6th month after the close of the partnership's tax year to file. If you need more time to file Form 8804, you may file Form 2758 to request an extension. Form 2758 does not extend the time to pay the tax.

Form 8805, Foreign Partner's Information Statement of Section 1446 Withholding Tax. Form 8805 is used to show the amount of effectively connected taxable income and any withholding tax payments allocable to a foreign partner for the partnership's tax year. At the end of the partnership's tax year, Form 8805 must be sent to each foreign partner whether or not any withholding tax is paid. It should be delivered to the foreign partner by the due date of the partnership return (including extensions). A copy of Form 8805 for each foreign partner must also be attached to Form 8804 when it is filed.

A copy of Form 8805 must be attached to the foreign partner's U.S. income tax return to take a credit on its Form 1040NR or Form 1120-F.

Form 8813, Partnership Withholding Tax Payment Voucher (Section 1446). This form is used to make payments of withheld tax to the United States Treasury. Payments must be made in U.S. currency by the payment dates (see Date payments are due, earlier).

Penalties. A penalty may be imposed for failure to file Form 8804 when due (including extensions). It is the same as the penalty for not filing Form 1042 discussed earlier under Returns Required.

A penalty may be imposed for failure to file Form 8805 when due (including extensions) or for failure to provide complete and correct information. The amount of the penalty depends on when you file a correct Form 8805. The penalty for each Form 8805 is:

1. $15 if you file a correct form within 30 days, with a maximum penalty of $75,000 per year ($25,000 for a small business), or
2. $50 if you file after 30 days or do not file a correct form, with a maximum penalty of $250,000 per year ($100,000 for a small business).

A small business is a business that has average annual gross receipts of not more than $5 million for the most recent 3 tax years (or for the period of its existence, if shorter) ending before the calendar year in which the Forms 8805 are due.

If you fail to provide a complete and correct Form 8805 to each partner, a penalty of $50 for each failure may be imposed. The maximum penalty is $100,000 per year.

If you intentionally disregard the requirement to report correct information, the penalty for each Form 8805 is the greater of $100 or 10% of the total amount of the items that must be reported, with no maximum penalty.

Identification numbers. A partnership that has not been assigned a U.S. TIN must obtain one. If a number has not been assigned by the due date of the first withholding tax payment, the partnership should enter the date the number was applied for on Form 8813 when making its payment. As soon as the partnership receives its TIN, it must immediately provide that number to the IRS.

To ensure proper crediting of the withholding tax when reporting to the IRS, the partnership must include each partner's U.S. TIN on Form 8805. If there are partners in the partnership without identification numbers, the partnership should inform them of the need to get a number. See U.S. Taxpayer Identification Numbers, earlier.

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