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Foreign Withholding Information Reporting

The Internal Revenue Service recently announced that it is sharpening its focus on the responsibility of U.S. taxpayers to report payments and withhold federal income tax from payments to foreign persons.

Income Subject to Withholding

Effectively Connected Income—Effectively connected income (ECI) is income associated with conduct of a particular U.S. trade or business and is subject to federal income tax at normal graduated rates. Some hedge funds have crossed the line and have been determined to be in the trade or business of lending money. In the case of partnerships with foreign partners, the partnership is required to withhold tax on ECI if the income is allocable to a foreign partner. The partnership must withhold tax equal to 35% for all foreign partners and remit this tax to the IRS. Applicable forms are as follows:

• Form 8804, Annual Return for Partnership Withholding Tax, due on April 15, 2009 (May file for a five-month extension using Form 7004)
• Form 8805, Foreign Partner's Information Statement of Section 1446 Withholding Tax, due on April 15, 2009 (May file for a five-month extension using Form 7004)
• Form 8813, Partnership Withholding Tax Payment Voucher, due quarterly

For foreign withholding in regard to the ownership of U.S. real estate, see our article "Foreign Investment in U.S. Real Property."

Fixed, Determinable, Annual or Periodic Income (FDAP)—U.S. source nonbusiness income that is fixed, determinable, annual or periodic income (FDAP) is subject to federal income tax at a flat 30% rate and is subject to withholding at source. Typical examples of FDAP include dividends, rent, royalties, some types of interest income, pensions, annuities and personal service income. Please note that the United States has treaties with multiple countries that can lower or even eliminate the withholding. However, these treaties do not eliminate the reporting requirement.

The withholding obligation is imposed on all persons having the control, receipt, custody, disposal or payment of these types of U.S. source income of any nonresident alien individual or foreign partnership. Applicable forms are as follows:

• Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, due on March 15, 2009 (may file for a six-month extension using Form 7004)
• Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, due on March 15, 2009 (may file for a 30-day extension using Form 8809)

Payments

This article does not address the timing with which foreign withholding must be remitted to the IRS. In some situations, the deposit must be made quarterly or more often.

Required Documentation

Various exemptions or reductions in the tax rate provided by bilateral income tax treaties entered into by the United States might also be available. The treaties can reduce or eliminate U.S. income tax on FDAP received by foreign persons who qualify for treaty benefits. To be relieved from liability for U.S. withholding tax, the payee must provide the withholding agent with an applicable Form W-8 to qualify for such an exemption or reduced rate. Form W-8s should be requested before making a payment. Applicable Form W-8s are as follows:

• Form W-8ECI—Certifies exemption based on income being ECI
• Form W-8BEN—Certifies foreign status and claims treaty exemption or rate reduction
• Form W-8EXP—Certifies eligibility for exemption for foreign governments or foreign tax-exempt organizations
• Form W-8IMY—Certifies status as a foreign intermediary or pass-through entity to withholding agent

If you have any questions, please contact Jennifer Zamarin at 312-980-3317 or Mike Calahan at 312-980-2996 for more information.

This publication is part of Blackman Kallick’s marketing of professional services, and is not written tax advice directed at the specific facts and circumstances of any person and/or entity. Contents of this publication are of a general nature, and you should not act on this information without obtaining professional advice from your business advisor that is appropriately tailored to your individual needs and circumstances. This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.