presents Form 1042 Compliance and Audit...

presents

Form 1042 Compliance and Audit Strategies Navigating Rules for Withholding on U S -Source Income

presents

Navigating Rules for Withholding on U.S.-Source Income for Foreign Persons

A Live 110-Minute Teleconference/Webinar with Interactive Q&A

Today's panel features:Laurie Hatten-Boyd, Principal, Information Reporting Practice, KPMG, Seattle

Cyrus Daftary, Partner, Burt, Staples and Maner, BostonJerri Langer, Principal, COKALA Information Services, Sacramento, Calif

Dominick Dell'Imperio, Partner and FSE Director, PricewaterhouseCoopers, New York

Wednesday, August 4, 2010

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Form 1042 Compliance AndForm 1042 Compliance And Audit Strategies Webinar

Aug. 4, 2010

Laurie Hatten-Boyd, [email protected]

Cyrus Daftary, Burt, Staples and Maner [email protected]

Jerri Langer, COKALA Information Dominick Dell’Imperio, Services PricewaterhouseCoopersServices [email protected] [email protected]

Today’s ProgramApproaches to Chap. 4 Withholding And Form 1042 Slides 6-26 Compliance (Laurie Hatten Boyd)(Laurie Hatten-Boyd)

Form 1042 Audits And Sample IDRs Slides 27-40

(Cyrus Daftary)

Common Mistakes In Form 1042 Compliance Slides 41-55

(Jerri Langer)

Form 1042 Audit Preparation Approaches Slides 56-66

(Dominick Dell’Imperio)

5

A h T Ch 4Approaches To Chap. 4 Withholding And Form g

1042 Compliance

Laurie Hatten-Boyd, KPMGLaurie Hatten Boyd, KPMG

Agenda For This SectionAgenda For This Section

Foreign Account Tax Compliance Act (FATCA)Foreign Account Tax Compliance Act (FATCA)New Chap. 4 withholding regimeNew Chap. 4 withholding regime

f S ff S fEvolution of IRS enforcement initiative under current Evolution of IRS enforcement initiative under current Chap. 3 withholding regime (Form 1042)Chap. 3 withholding regime (Form 1042)

©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. 7

Foreign Account Tax Foreign Account Tax C li A t (FATCA)C li A t (FATCA)Compliance Act (FATCA)Compliance Act (FATCA)


Withholding - Current RulesWithholding - Current Rules

The current 1441 withholding rules wereThe current 1441 withholding rules were designed to ensure that designed to ensure that the correct withholding and reporting occurs on U.S.the correct withholding and reporting occurs on U.S.--source source FDAP, based on the tax status of the beneficial owner of the FDAP, based on the tax status of the beneficial owner of the income.income.

Under these rules, a U.S. person can avoid disclosure by:Under these rules, a U.S. person can avoid disclosure by:Investing in U.S.Investing in U.S.--source income through offshore corporation (0% source income through offshore corporation (0% gg g p (g p (on portfolio interest and broker proceeds; 30% on dividends)on portfolio interest and broker proceeds; 30% on dividends)Investing in U.S.Investing in U.S.--source income through foreign partnership as source income through foreign partnership as undisclosed owner (30% on interest and dividends; 0% on broker undisclosed owner (30% on interest and dividends; 0% on broker ( ;( ;proceeds)proceeds)Investing directing in nonInvesting directing in non--U.S. assets (no reporting for payments of U.S. assets (no reporting for payments of nonnon--U.S.U.S.--source income by nonsource income by non--U.S. payor outside the U.S.)U.S. payor outside the U.S.)


yy p y )p y )

FATCA WithholdingFATCA Withholding

New withholding regime aimed at expanding reporting New withholding regime aimed at expanding reporting of U.S. persons investing offshoreof U.S. persons investing offshore

Disclosure of U.S.Disclosure of U.S.--owned foreign entitiesowned foreign entities


Overview Of RequirementsOverview Of Requirements

30% withholding on any withholdable payment made 30% withholding on any withholdable payment made g y p yg y p yto a foreign financial institution (FFIto a foreign financial institution (FFI), ), unless FFI enters unless FFI enters into a into a disclosure agreement disclosure agreement with the IRSwith the IRS

ThTh tt ill i FFI t id tif U Sill i FFI t id tif U SThe The agreement agreement will require FFI to identify U.S. will require FFI to identify U.S. accounts and to report these to the IRS on an annual accounts and to report these to the IRS on an annual basisbasis

Previously, Previously, only required to look only required to look through flowthrough flow--through through entities such as partnerships and certain trustsentities such as partnerships and certain trusts

Will b i d t l kWill b i d t l k th hth h ll titll tit tt ithithWill be required to look Will be required to look through through all entity all entity types, types, with with limited exceptionslimited exceptions


©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. Printed in the U.S.A. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative, a Swiss entity.

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Definitions: Withholdable PaymentDefinitions: Withholdable Payment

Any payment of U.S.Any payment of U.S.--source FDAP income (e.g. source FDAP income (e.g. y p yy p y ( g( gdividends, interest, OID, rents), anddividends, interest, OID, rents), and

Any gross proceeds from the sale or other disposition Any gross proceeds from the sale or other disposition of a security that can give rise to the payment of U.S.of a security that can give rise to the payment of U.S.--source dividends or interestsource dividends or interestsource dividends or interestsource dividends or interest

Exclusion: Income that is effectively connected to the Exclusion: Income that is effectively connected to the conduct of a trade or business within the U.S. conduct of a trade or business within the U.S. Unknown at this time: Vendor paymentsUnknown at this time: Vendor payments



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Definitions: Foreign Financial InstitutionDefinitions: Foreign Financial Institution

A financial institution is defined as any entity that:A financial institution is defined as any entity that:y yy y

•• Accepts deposits in the ordinary course of businessAccepts deposits in the ordinary course of business

•• Is in the business of holding financial assets for others, orIs in the business of holding financial assets for others, or

•• Is primarily engaged in the business of investing, Is primarily engaged in the business of investing, reinvesting or trading in securities, partnership interests, reinvesting or trading in securities, partnership interests, commodities or any interest in such instrumentscommodities or any interest in such instrumentscommodities or any interest in such instrumentscommodities or any interest in such instruments

–– Given this broad definition, an FFI includes hedge funds, private equity Given this broad definition, an FFI includes hedge funds, private equity funds and other collective investment vehicles.funds and other collective investment vehicles.



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Definition – U.S. AccountDefinition – U.S. Account

U.S. accountU.S. accountDepository or custodial account maintained by the financial Depository or custodial account maintained by the financial institution, as well as any debt or equity interest in the financial institution, as well as any debt or equity interest in the financial institution, held by a specified U.S. person or U.S.institution, held by a specified U.S. person or U.S.--owned foreign owned foreign entityentityentity entity

Specified U.S. personSpecified U.S. person is generally a U.S. nonis generally a U.S. non--exempt recipient exempt recipient (individual trust partnership or estate) and privately held U S(individual trust partnership or estate) and privately held U S(individual, trust, partnership or estate) and privately held U.S. (individual, trust, partnership or estate) and privately held U.S. corporationcorporation

U.S.U.S.--owned foreign entityowned foreign entity is one with substantial U.S. ownersis one with substantial U.S. ownersg yg yCorporation or partnership in which specified U.S. person owns 10%, Corporation or partnership in which specified U.S. person owns 10%, directly or indirectly.directly or indirectly.Investment vehicles Investment vehicles –– 10% is reduced to 0%, so any U.S. ownership10% is reduced to 0%, so any U.S. ownership


The Disclosure AgreementThe Disclosure Agreement

The foreign financial institution must undertake to:The foreign financial institution must undertake to:gg•• Obtain information from “account holders,” to determine Obtain information from “account holders,” to determine

which are U.S. accountswhich are U.S. accounts•• Comply with due diligence procedures (to be specified)Comply with due diligence procedures (to be specified)•• Report annually for U.S. accountsReport annually for U.S. accounts

Provide further information upon requestProvide further information upon request•• Provide further information upon requestProvide further information upon request

Banking secrecy jurisdiction considerationsBanking secrecy jurisdiction considerationsBanking secrecy jurisdiction considerationsBanking secrecy jurisdiction considerations

Model agreement?Model agreement?


gg

15


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ReportingReporting

The foreign financial institution will be required to The foreign financial institution will be required to g qg qreport the following:report the following:

•• Name, address and TIN of each account holder who is Name, address and TIN of each account holder who is ifi d U Sifi d U Sa specified U.S. persona specified U.S. person

•• Name, address and TIN of each substantial U.S. owner Name, address and TIN of each substantial U.S. owner of a U.Sof a U.S..--ownedowned foreign entityforeign entityof a U.Sof a U.S.. owned owned foreign entityforeign entity

•• The account numberThe account number•• The account balance or value (timing, calculation The account balance or value (timing, calculation

method to be determined)method to be determined)•• Gross receipts to and withdrawals/payments from the Gross receipts to and withdrawals/payments from the

account (also to be determined)account (also to be determined)


account (also to be determined)account (also to be determined)

16©2010 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative, a Swiss entity. Printed in the U.S.A. All rights reserved. KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative, a Swiss entity. 52379NYO

Other Foreign EntitiesOther Foreign Entities

30% withholding also applies to withholdable 30% withholding also applies to withholdable g ppg pppayments made to foreign nonpayments made to foreign non--financial entities (FEs). financial entities (FEs). An FE is any entity that is not an FFI. To avoid this An FE is any entity that is not an FFI. To avoid this withholding the FE must:withholding the FE must:withholding, the FE must:withholding, the FE must:

•• Provide a certification to the withholding agent that it Provide a certification to the withholding agent that it does not have any U.S. substantial owners, ordoes not have any U.S. substantial owners, or

•• Provide the name, address and TIN of any U.S. Provide the name, address and TIN of any U.S. substantial owners to the withholding agentsubstantial owners to the withholding agent

The withholding agent will then report to the IRS.The withholding agent will then report to the IRS.



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Exempt Beneficial OwnersExempt Beneficial Owners

Payments Payments to the following will not be subject to to the following will not be subject to withholding or reporting:withholding or reporting:

•• Foreign governmentsForeign governments•• International organizationsInternational organizations

Foreign central banks andForeign central banks and•• Foreign central banks, andForeign central banks, and•• Any other beneficial owners identified as posing a low Any other beneficial owners identified as posing a low

risk of tax evasionrisk of tax evasion



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Effective DateEffective Date

Payments Payments made after made after Dec. Dec. 31, 201231, 2012

Grandfather Grandfather provision:provision: Withholding exclusion on any payment under any Withholding exclusion on any payment under any

obligation outstanding on March 18, obligation outstanding on March 18, 2012; 2012; OROR Gross proceeds from any disposition of such anGross proceeds from any disposition of such an Gross proceeds from any disposition of such an Gross proceeds from any disposition of such an

obligationobligation



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IRS Sect. 1441 IRS Sect. 1441 Compliance InitiativeCompliance Initiative


IRS Now Has Significant Interest In Sect. 1441 Compliance

IRS Now Has Significant Interest In Sect. 1441 ComplianceSect. 1441 ComplianceSect. 1441 Compliance

For the first time in more than 15 years, the IRS is aggressively For the first time in more than 15 years, the IRS is aggressively pursuing withholding agents’ compliance with the Sect. 1441 pursuing withholding agents’ compliance with the Sect. 1441 withholding rules.withholding rules.

The IRS has been preparing for Form 1042 audits for several years. The IRS has been preparing for Form 1042 audits for several years. As part of this preparation, it has:As part of this preparation, it has:

Drafted new sections for auditing US withholding agents in the Internal Drafted new sections for auditing US withholding agents in the Internal Revenue ManualRevenue Manual

Trained more than 2000 examiners andTrained more than 2000 examiners andTrained more than 2000 examiners, andTrained more than 2000 examiners, and

Created a national team in New York to assist auditors around the country Created a national team in New York to assist auditors around the country with the routine implementation of these auditswith the routine implementation of these audits


Sect. 1441 Background InformationSect. 1441 Background Information

Under the old regulations:Under the old regulations:

Form WForm W--8 for Code exceptions8 for Code exceptions

“Address rule” for dividends“Address rule” for dividendsAddress rule for dividendsAddress rule for dividends

IRS was aware the rules were inadequate and that there was mass nonIRS was aware the rules were inadequate and that there was mass non--compliance. Specifically, the IRS was aware that:compliance. Specifically, the IRS was aware that:

Foreign Intermediaries provided Form WForeign Intermediaries provided Form W--8 for Code exceptions, and8 for Code exceptions, and

Dividend rate was based on the address of the foreign intermediaryDividend rate was based on the address of the foreign intermediaryDividend rate was based on the address of the foreign intermediaryDividend rate was based on the address of the foreign intermediary

The IRS decided to halt enforcement action until it could promulgate new The IRS decided to halt enforcement action until it could promulgate new rules to address these problems.rules to address these problems.


“New” 1441 Regulations“New” 1441 Regulations

New regulations released in 1997 (effective for payments after New regulations released in 1997 (effective for payments after 1/1/2001)1/1/2001)

Key to new regulations is documentationKey to new regulations is documentation

Family of Forms WFamily of Forms W--8 (W8 (W--8BEN, W8BEN, W--8IMY, W8IMY, W--8ECI and W8ECI and W--8EXP) 8EXP)

Due diligence requirements (no conflicting information with claims made)Due diligence requirements (no conflicting information with claims made)

Mandatory presumption rules in which documentation is missing or invalidMandatory presumption rules in which documentation is missing or invalid

2001 was “transition year”; IRS agreed not to audit.2001 was “transition year”; IRS agreed not to audit.

During this time, the IRS discussed strict auditing standards at various During this time, the IRS discussed strict auditing standards at various conferences.conferences.


US withholding agents performed “health checks” using the stated standards US withholding agents performed “health checks” using the stated standards and realized compliance levels were still inadequate; sought IRS help.and realized compliance levels were still inadequate; sought IRS help.

Voluntary Compliance Program (VCP)Voluntary Compliance Program (VCP)

Withholding agents came forward voluntarilyWithholding agents came forward voluntarilyExplained compliance problems in detailExplained compliance problems in detailNegotiated lower standards for acceptance of formsNegotiated lower standards for acceptance of formsEliminated interest for failure to withhold if no taxEliminated interest for failure to withhold if no taxEliminated interest for failure to withhold, if no taxEliminated interest for failure to withhold, if no tax

Resulted in retroactive withdrawal of Sect. 1.1441Resulted in retroactive withdrawal of Sect. 1.1441--1(b)(7)(iii)1(b)(7)(iii)

IRS l d t d l th h thiIRS l d t d l th h thiIRS learned a great deal through this processIRS learned a great deal through this processTypes of income commonly missed by withholding agentsTypes of income commonly missed by withholding agentsTypes of industries in which nonTypes of industries in which non--compliance was commoncompliance was commonSignificant questions to ask on auditSignificant questions to ask on auditHow to train auditors How to train auditors


Updated Internal Revenue Manual (July 2008)Updated Internal Revenue Manual (July 2008)

In response to VCP, IRS updated its IRM to include In response to VCP, IRS updated its IRM to include p pp psections on auditing US withholding agentssections on auditing US withholding agents

AddedAdded SectSect 4 10 214 10 21Added Added Sect. Sect. 4.10.214.10.21

IRM provides solid background information on IRM provides solid background information on withholding requirements and types of income that may withholding requirements and types of income that may be subject to be subject to withholding.withholding.

IRM broken into two IRM broken into two categories:categories:Financial Financial institutionsinstitutionsNonNon financial institutionsfinancial institutions


NonNon--financial institutionsfinancial institutions

Withholding – Tier 1 DesignationWithholding – Tier 1 Designation

Tier 1 designation for withholdingTier 1 designation for withholding−− What does this generally mean?What does this generally mean?

IRS believes it is issue of “high strategic importance”IRS believes it is issue of “high strategic importance” Designation of owner executive/issue management teamDesignation of owner executive/issue management team LMSB technical advisorLMSB technical advisor

--Significant counsel role in casesSignificant counsel role in cases-- Examiners must considerExaminers must consider

−− What has this specifically meant for withholding?What has this specifically meant for withholding?p y gp y g Increase in the number of compliance audits Increase in the number of compliance audits

Tremendous increase in the number of IDRsTremendous increase in the number of IDRs Also large increase in the number of informal requestsAlso large increase in the number of informal requests


Form 1042 Audits And S l IDRSample IDRs

Cyrus Daftary, Burt, Staples and ManerCyrus Daftary, Burt, Staples and Maner

Agenda For This Section

Significance of information return reporting and g p gtax withholding

IRS withholding tax audit activity IRS approach to Form 1042 examinations Sample IDRs

Addi i l h h h l Additional thoughts on what else to expect during the audit

Penalties Penalties

28

Significance Of Information Return Reporting And Tax WithholdingReporting And Tax Withholding

Voluntary compliance program (Rev. Proc. 2004-59) Post-VCP disclosures IRS publishes the Form 1042 IRM IRS elevates withholding tax to Tier 1 audit issue Heightened scrutiny on tax havens and bank secrecy

jurisdictionsjurisdictions President Obama – General explanations of FY10

revenue proposals (“Greenbook”) released 5/11/09 Foreign Account Tax Compliance Act (FATCA)

becomes law in March 2010

29

IRS Withholding Tax Audit Activity

Common misperception that IRS is only auditing financial institutions on withholding tax issues

IRS is well aware that withholding tax compliance can be quite spotty at non-financial institutionscan be quite spotty at non-financial institutions.

IRS expects Form 1042 reviews to be done in conjunction with Form 1120 and Form 945 audits (even seen with Form 1065 audits). Substantial number of such audits under way at both

financial institutions and non-financial companiesfinancial institutions and non financial companies Significant increase in audits during 2010

IRS actively searching Forms 5471, 5472 and 1118 d b fi d fildatabases to find Form 1042 non-filers

30

IRS Approach To Form 1042 ExaminationsExaminations

IRS will issue IDRs based on the DeNard Industry yDirective (11/05/03) and the Internal Revenue Manual (IRM 4.10.21).

Goal of IDRs is consistent with Industry Directive: Goal of IDRs is consistent with Industry Directive: Have you accurately determined who you are paying? Have you accurately determined what you are paying? Have you taxed the payments appropriately, based on the

nature of the payments, the documentation and the rules? Have you reported the income properly? Have you reported the income properly?

31

Sample IDRs

Please provide copies of IRS Forms 1042 and Forms 1042-S for calendar year 200x

Work papers and other supporting documentation used in the preparation of the documentation used in the preparation of the Forms 1042 and 1042-S requested above

Listing of names and departments of those g ppersons who had primary responsibility for the preparation of Forms 1042 and 1042-SC i f F W 8 li it d f th Copies of Forms W-8 solicited from the payee and received by the taxpayer. The Service will inform the taxpayer specific payees whom it will want to review.

32

Sample IDRs (Cont.)

Any and all internal audit reports, for the covered dit th t t i t th t ’ fid i audit years, that pertain to the taxpayer’s fiduciary

activities as a U.S. withholding agent, including but not limited to: Customer account openings, including practices/procedures Documentation and validation, including practices and

procedures (U S vs foreign status entity type etc )procedures (U.S. vs. foreign status, entity type etc.) Renewal of expiring or invalid Forms W-8 Recording of transactions of underlying customer accounts Determination of the source of the income payment (U.S. vs.

foreign) Type/character of income (dividend vs. interest) Application of withholding and reporting

33

Sample IDRs (Cont.)

Any and all operating manuals and written d f th d dit th t t i t procedures for the years under audit, that pertain to

fiduciary activities including but not limited to: Customer account openings, including practices/proceduresp g , g p /p Documentation and validation procedures (U.S. vs. foreign

status, entity type, etc.) Renewal of expiring or invalid Forms W-8 Renewal of expiring or invalid Forms W 8 Recording of transactions of underlying customer accounts Determination of source of the income payment (U.S. vs.

foreign)foreign) Type of income (dividend vs. interest) Application of withholding and reporting

N i l d d f h h h d Names, titles and departments of those persons who had primary responsibility for the functions mentioned above

34

Sample IDRs – Vendor Payments

Please indicate your procedures to determine h th t iwhether a payment is:

Made or credited to a foreign person (country of residence, mailing address where check is mailed, wire instructions if payment made electronically)

A payment that is fixed or determinable annual or periodical (FDAP), or

U.S.-source, i.e. personal services, software, royalties, communications

Provide in electronic format an accounts payable Provide in electronic format an accounts payable register and/or a vendor file reflecting the names and addresses of all vendors, so that the Service will be able to identify payments and/or wire will be able to identify payments and/or wire transfers to non-U.S. persons

35

Sample IDRs – Vendor Payments (Cont.)(Cont.)

Copies of Forms W-8 and 8233 solicited from the payee. The Service will inform the taxpayer-specific payees which it will want to review.

Provide a list of all departments that make payments to all foreign individuals and/or entities. The term g /payment includes, but is not limited to: Payments to foreign vendors Payments to foreign related parties (for services) or Payments to foreign related parties (for services), or Payments of pension benefits to foreign persons

36

Sample IDRs (Cont.)

Securities lending/syndicated loan fees Fees (rebates)/facility fees, commitment fees, letter of

credit, up-front fees, breakage fees, underwriting fee, etc.

Total return swaps (four scenarios) Cross-in/cross-outs Cross-in/inter-broker dealer cross-Out Cross in/inter broker dealer cross Out Cross-in/foreign affiliate out Full synthetic

VCP commitments NPCs Related party payments including payments to QIs Related party payments, including payments to QIs

37

Additional Thoughts On What To Expect During The AuditTo Expect During The Audit

Comprehensive IRS team

IRS’ IDRs have gotten a lot more detailed and sophisticated than in the past and can be tailored to specific business units.p

IRS will expect to see Forms W-8 for each NRA to which payments were made (even if no reporting required) and Form W 9 for each U S non exempt required), and Form W-9 for each U.S. non-exempt recipient selected in the sample (certainty and non-certainty).

Soliciting new Forms W-8 during audit (after sample selection)

IRS i th t ll t h ld d t IRS concern is that all account holders, vendors, payees, etc. are properly documented at the time of the payment.

38

Additional Thoughts On What To Expect During the Audit (Cont )Expect During the Audit (Cont.) IRS expects to see core systems:

Default logic and controls must be in place.

Systems flowsy

IRS audit plans contemplate interviewing staff.

IRS may require the USWA to file corrected Forms IRS may require the USWA to file corrected Forms 1099 and/or 1042-S.

USWA may need to file amended Forms 1042 & 945.y

Penalties

Closing agreement Closing agreement

39

Penalties

IRC Sect. 6651 – Failure to file or pay tax

IRC Sect. 6621 – Interest on underpayment

IRC Sect. 6656 – Failure to depositp

IRC Sect. 6662 – Accuracy-related

IRC Sect 6663 – Fraud IRC Sect. 6663 Fraud

IRC Sect. 6694 – Reckless or intentional disregard

IRC S t 6721 F il t fil i f ti t IRC Sect. 6721 – Failure to file information returns

IRC Sect. 6722 – Failure to furnish payee statementsstatements

40

Common Mistakes In F 1042 C liForm 1042 Compliance

Jerri Langer, COKALA Information ServicesJerri Langer, COKALA Information Services

Agenda For This Section

42

Agenda For This Section Importance of making sure your 1042 account at the IRS Service

C t i i b l ith dCenter is in balance with your records Pointers in keeping your 1042/1042-S forms accurate and in

balance How Ogden Service Center processes 1042 filings; how 1042-S

forms are reconciled How deposits are matched to 1042 liabilities and assessments are p

generated How to request and deal with transcripts Actions to take when transcripts are out of balance Actions to take when transcripts are out of balance How multiple amendments and year-end corrections can cause

difficultiesP i b 1042 fili i di

COKALA Tax Information Reporting Solutions, LLC 42

Pointers about 1042 filings in an audit context

43

1042 Is A Reconciliation:1042 Is A Reconciliation: IRS Matches Deposits Against 1042 Data First step to a correct 1042: Review all 1042 deposits for the year.

The 1042 is intended to reconcile the deposits and liabilities. A perfect 1042 could still generate IRS assessments if deposits were

handled incorrectly. Request IRS 1042 transcript at year-end through the IRS eservice

system, or your assigned liaison if you are a large LMSB taxpayer, or by contacting the IRS Service Center where you file.

Match against company deposit records Verify that all deposits were correctly posted Verify that no assessments have caused the IRS to reallocate deposits After 1042 filing, get an end-of-quarter transcript and verify that

liabilities are correctly posted


44

Mechanics That Cause ProblemsMechanics That Cause Problems In Deposits

A previous year’s deposit must be made separately from your regular current -year deposit, so check the IRS transcript to verify that the beginning and end-of-year postings are correctbeginning and end of year postings are correct.

A 1042 deposit must be made separately from a deposit of any other type of tax. If i i d it i th t i t h k h th it If you are missing a deposit in the transcript, check whether it may have been posted to a different account for your company in IRS records, e.g. 945 (back-up withholding or retirement) or 941 (payroll).

If you ask IRS to move funds to correct a transcript: Make sure they move as of date actually deposited, or you will be assessed for late deposit (get another, follow-up transcript to check on this).


45

IRS System Will Quickly FindIRS System Will Quickly Find An Out-of-Balance Form 1042

Ogden IRS Service Center is now in charge; expect tolerance levels to fall and assessments to increase.

More than 1 000 edits are used to review Forms 1042 S and where More than 1,000 edits are used to review Forms 1042-S, and where differences are found, IRS recalculates your deposit liability and deposit date.IRS id tifi d it li bilit d t d IRS program identifies your deposit liability dates and compares those against your deposits as shown on the IRS transcript.

If your 1042 is not in balance with your 1042-S forms, assessments b i ifi t d i d dit i kcan be significant and pose increased audit risk.

Worst case: Be selected for an audit and have your 1042 out of balance with the Service Center records – that means the agent has diff i b h d !


different starting numbers than you do!

4545

46

Target The File Clean-up Period:Target The File Clean up Period: Jan. 1 To March 15!

Mission: IRS gives you until March 15 each year to fix payee errors before you provide 1042-S to payee. Target that period to clean up files! Make sure you:y

1. Set a cut-off date for corrections in your procedures that is early enough to allow you to balance and prepare 1042/1024-S before due dates

2. Publish to the business side and to payees the correction cut-off date and process

3. Develop formal payee correspondence on the correction cut-off date that serves notification that once past that date, payee will need to file IRS tax return to gain refund


return to gain refund

47

Some Rules To Help You File only one Form 1042 per EIN, so that you consolidate all Form 1042-

S information regardless of the number of different clients, branches, divisions business units or types of income being paid (remember treasury

p

divisions, business units or types of income being paid (remember treasury functions, accounts payable area, customers)

Use same payer name and EIN to file 1042 and 1042-S and make deposits; IRS does a payer name/EIN match before accepting the 1042deposits; IRS does a payer name/EIN match before accepting the 1042

Avoid rounding errors: Form instructions allow rounding off cents to whole dollars, but if you do round to whole dollars, you must round all

t T d ff t t th t h l d ll d tamounts. To round off amounts to the nearest whole dollar, drop amounts under 50 cents and increase amounts from 50 to 99 cents to the next dollar. For example, $1.39 becomes $1 and $2.50 becomes $3.

E l If h dd fi h Error alert: If you have to add two or more amounts to figure the amount to enter on a line, include cents when adding and only round off the total; otherwise, you may end up with a very large imbalance with 1042-S totals.


48

Some Rules To Help You (Cont.) Do not file the 1042 until you know your figures from 1042-S

forms are final; any corrections in your 1042-S forms will affect 1042

p ( )

your 1042 If your tax dept. files your 1042, and operations files 1042-S forms,

make sure you obtain extensions to give you time to reconcile Extension of time to file 1042: Use Form 7004, Application for

Automatic 6-Month Extension of ... Need to be fully paid by original non extended due date of the Need to be fully paid by original non-extended due date of the

1042 … so if you think you may be short in deposits, pay more when you apply for extension or you will be assessed penalties and interest when you finally file your 1042

Extension of time to file 1042-S: Use Form 8809 (same as 1099) d it l tt t IRS M ti b C ti C t f


and write letter to IRS Martinsburg Computing Center for payee extension

49

Extensions Are Normal And Necessary It is okay to have a practice every year of applying for extensions,

giving you time to reconcile and make sure filings are correct

Extensions Are Normal And Necessary

giving you time to reconcile and make sure filings are correct. If you get an extension for 1042-S forms but forget to get extension

for the 1042 and thus file 1042 late, you have a big problem, particularly if you have not fully paid your liabilities.

Penalty for not being fully paid by 3/15/2011: 0.05% (.005) of the tax not paid by the regular due date, for each month or partial month p y g , punpaid, up to 25% of the unpaid tax, with interest on taxes not paid by the due date even if an extension of time to file is granted

Penalty for not filing Form 1042 when due (including Penalty for not filing Form 1042 when due (including extensions): 5% of the unpaid tax for each month or part of a month the return is late, up to 25% of the unpaid tax


IRS usually applies the larger of these calculations (not both).

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Steps In Reconciling For 1042 Preparation1. Match IRS transcript dates and amounts against your own deposit records2 Match your deposit records to liability dates recorded in your records

Steps In Reconciling For 1042 Preparation

2. Match your deposit records to liability dates recorded in your records, remembering bank holidays

3. Balance total 1042-S liabilities in your books and records against totals from your trial-run 1042-S forms If out-of-balance research and correct Freezeyour trial-run 1042-S forms. If out-of-balance, research and correct. Freeze your 1042-S filing data so that you see incoming corrections and make adjustments later

4 Verify that the amount of 1042 withholding in your deposit record was the4. Verify that the amount of 1042 withholding in your deposit record was the total amount transferred to your reporting system, and if not, research and fix

5. Validate year-end deposit adjustments to ensure they are correctly posted in the IRS transcriptsthe IRS transcripts

6. If all in balance between 2010 liabilities in your books and records, 2010 actual deposits and your 2010 Form 1042-S reports, move to 1042 completion. Correct all errors before you proceed with the 1042


p y p

51

If Not In Balance, Take These Steps Watch for corrections processed through the system after the freeze in prep for

last year’s return filing. These can cause incorrect negative withholding amounts

If Not In Balance, Take These Steps

in the current-year process. Look for negative 1042-S amounts and correct them, since negatives are not

allowed in the filing process. You may need to amend a previous year’s 1042 and reverse in the current year. Remember that you cannot refund withholding after you provide the 1042-S to the payee.

Where you find errors, correct the system of record if possible and then the current year’s reporting system.

Be sure all the refunds done during the year are correct on the reporting system and show the correct amount of withholding on the Forms 1042-S.

Ideally, you should be able to balance to the penny. If you balance to only a very small difference, the difference could be due to rounding errors.

If you have combined multiple systems to obtain the Forms 1042-S reporting for h h fi b l h


the year, then first balance the separate systems.

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If Not In Balance, Take These Steps (Cont.)• If the amount of withholding on the Forms 1042-S is less than the amount of

liabilities you calculated, it is likely that the imbalance was caused by an error in

If Not In Balance, Take These Steps (Cont.)

liabilities you calculated, it is likely that the imbalance was caused by an error in a refunding transaction.

• See if you can find all refunding transactions and confirm that the liabilities to the IRS were reduced by the correct amount (and on the right date). This may y ( g ) yrequire a full review of the daily logs or primary system of record.

• If the total withholding on the 1042-S forms is more than the amount of liabilities you calculated, then it is likely that a liability was not recorded

lcorrectly.• Now, attempt to match the liabilities from your primary systems to the recorded

liabilities, looking for a missed date or a transposition that caused the amount to be incorrectly recordedbe incorrectly recorded

• Errors, whose sum of the digits is divisible by 9, are likely to be transpositions. Performing the summing of the out-of-balance total number prior to the review may help you find it more quickly


53

Amended Returns You cannot amend Form 1042 to recover taxes over-withheld in the prior year if

you have already provided the 1042-S to the payee reporting the withholding, or if it is after March 15 of the ear follo ing the ear of pa mentif it is after March 15 of the year following the year of payment.

But, you can amend administrative errors with which you completed the 1042 incorrectly, but provided the correct 1042S- to payee.

If you amend too many times and close together, IRS can get them out of y y g , gsequence and really mess up your transcripts.

If you have to make changes to your Form 1042 after you submit it, file an amended Form 1042.

U th F 1042 f th di Use the Form 1042 for the year you are amending Check the “Amended Return” box at the top of the form You must complete the entire form, including all filing information for the

calendar year, and sign the return.calendar year, and sign the return. Attach a statement explaining why you are filing an amended return (for

example, you are filing because the tax liability for May was incorrectly reported due to a mathematical error)


54

If Math Errors On Form 1042:

IRS sends a CP 268 notice when a Form 1042 is out of balance or has

If Math Errors On Form 1042: IRS Sends CP 268

IRS sends a CP 268 notice when a Form 1042 is out of balance or has identifiable errors.

The tear-off stub of the CP 268 has a coding: 01 The balance due, or the amount designated overpaid, was not correct., g p ,

1042-S totals do not equal 1042 reported amounts02 An error was made when the total tax owed for the year was figured.

For example, negative amounts are entered as 1042-reported liabilities.

26 The amount reported as total federal tax deposits for the year was not correct.

L t d it h t d it h h t k d th f Late deposits, short deposits or where you have not marked the use of 90% method on 1042

90 Other specified reasons


These errors will require amending the 1042 unless IRS is correct …

Any tax advice included in this written or electronic communication was not intended or written to be used, and it cannot be used by the taxpayer, for the purpose of avoiding any penalties that may be imposed on the taxpayer by any governmental taxing authority or agency.


Form 1042 Audit P ti A hPreparation Approaches

Dominick Dell’Imperio,Dominick Dell Imperio, PricewaterhouseCoopers

What Has The IRS Been Doing?

Designated “withholding” as a Tier 1 issue

Learned how and where to look for non-compliance from Sect. 1441 Voluntary Compliance Program (“VCP”)

Published Internal Revenue Manual for Form 1042 examinations, to ensure quality and consistency in enforcement http://www.irs.gov/irm/part4/irm_04-010-021.html

Training more agents to examine withholding issues. Technical advisors experienced in withholding available to assist agents on exams

Cross-checking the information reporting it currently receives and enhancing its use of that information (Forms 1042-S, 5471, 5472)

Focused on accounts payable/vendor payments

PricewaterhouseCoopers

Focused on accounts payable/vendor payments

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What Is A Tier 1 Issue?Tier I - Active Status

Requires a continued level of coordination across the enterprise

1

What Is A Tier 1 Issue?

Tier I - Recognized Abusive & Listed Transactions

Recognized Abusive and Listed Transactions - LMSB Tier I Issues in Alphabetical Order

Tier I - High Risk Transactions1

§118 Abuse (Note: Environmental Remediation, Universal Service Fund and BioEnergy Payments subTier I Issues in Alphabetical Order

Recognized Abusive and Listed Transactions - LMSB Tier I Issues in Chronological Order

Universal Service Fund and BioEnergy Payments sub-issues are moved to monitoring - see below)

Foreign Earnings Repatriation Foreign Tax Credit Generators Mixed Service Costs (Note: Phase I has moved to

monitoring - see below)g ) Repairs vs. Capitalization Change in Accounting Method

(CAM) Research Credit Claims Transfer of Intangibles/Offshore Cost Sharing US Withholding Agents - §1441: Reporting and

Withh ldi US S FDAP IWithholding on US Source FDAP Income


1. Pose the highest compliance risk across multiple LMSB Industries and generally include large numbers of taxpayers, significant dollar risk, substantial compliance risk, or are high visibility.

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What Has The IRS Been Doing –G l Ob tiGeneral Observations

• Looking beyond what’s reported on Forms 1042 and 1042-S

• Applying a “strict liability” approach to all Forms W-8

• The persons directly responsible for collecting documentation, reviewing documentation and processing invoices may not be well g p g yversed in the NRA rules

S t 1441 i ti bj t t t d d i ti• Sect. 1441 examinations are subject to standard examination timeframes. It is unlikely additional time will be allowed to remediate documentation failures discovered during the examination.

PricewaterhouseCoopers 59

What Has The IRS Been Doing - Why Sh ld Y C ?Should You Care?

• Significant potential exposure, especially with respect to having “valid” Forms W-8

− Generally 30% withholding where forms are invalidGenerally 30% withholding where forms are invalid

− Withholding agent is liable for the amount of tax that should have been withheld, plus penalties and interest.

• IRS is considering restricting the ability to obtain “late” Forms W-8 to cure prior years, especially during an examination.

• Areas most susceptible to errors are frequently those out of the direct control and jurisdiction of the tax department.


Sect. 1441 - FDAP Payments And Who P ThPays Them

Type Of Income Department Most Likely ResponsibleType Of Income Department Most Likely Responsible

Compensation for personal services Accounts payable/payroll/treasury

Dividends Treasury/business unit/inter-companyI t t T /b i it/i tInterest Treasury/business unit/inter-company

Original issue discount/cancellation of debtTreasury/business unit

Pensions and annuities Payroll/human resources/business unitPensions and annuities Payroll/human resources/business unit

Royalties, license fees, etc. Accounts payable/inter-company/business unit

Taxable grants, prizes, awards and Accounts payable/marketing/payrollsponsorships Accounts payable/marketing/payroll

Legal awards Accounts payable/legalRents Accounts payable


What Did The IRS Learn - The Internal R M lRevenue Manual

• IRM Index:4.10.21 U.S. Withholding Agent Examinations - Form 10424.10.21.1 Introduction4 10 21 2 Basic Terms Defined4.10.21.2 Basic Terms Defined4.10.21.3 Impact of NRA Withholding Tax Law Changes Effective

20014 10 21 4 S f R l C d S i4.10.21.4 Summary of Relevant Code Sections4.10.21.5 Form 1099 Backup Withholding Tax vs. NRA Withholding

Tax4.10.21.6 Important Forms to Know4.10.21.7 Important Items to Consider for Pre-audit Planning4 10 21 8 U S Financial Institution Withholding Agent Audit


4.10.21.8 U.S. Financial Institution Withholding Agent Audit

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What Does The IRM Say?

The first step is a review of written procedure and training manuals such as:The first step is a review of written procedure and training manuals such as:

A. Summaries of withholding tax systemsB. System flow charts covering payments made to account holdersC. Internal control, audit reports or other information which relate to the

withholding tax function D. Manuals related to functions that may have withholding tax implications E. Training manuals for personnel for departments that control certain key

functionsfunctions

“


What To Do Next?What To Do Next?

“Evaluation of the above written procedures (or lack thereof) may provide theEvaluation of the above written procedures (or lack thereof) may provide the examiner with an indicator of the overall reliability of the taxpayer’s withholding tax functions. This assessment may assist in determining the extent of additional audit procedures, such as the review of account files statements p ,and withholding certificates.”

• Next steps:

Identify NRA account holders or vendors

Identify U S source payments to NRAsIdentify U.S. source payments to NRAs


Suggested Action Items For Multi-National CompaniesNational Companies

• Begin internal compliance health checks

• Understand the types of payments being made to NRAs:

− Do IT systems properly track and record payments to NRAs?

− Review internal procedures and training manuals

− Assess knowledge level of personnel

− Confirm Forms W 8 and 8233 are valid; if not re solicit− Confirm Forms W-8 and 8233 are valid; if not, re-solicit

− Determine if tax deposits are being made timely

• Don’t wait for the examination to find and fix problemsp

• Consider domestic reporting compliance


Common ErrorsCommon ErrorsCommon Pitfalls

I lid d t tiSpecific Documentation & Process Errors

E i d f• Invalid documentation• Conflicting information in files or

systems• Failure to obtain documentation

• Expired forms• Outdated form version used• Original form not provided

Form has U S address or address• Failure to obtain documentation• Presumption rules incorrectly applied

• Relying on presumption rules alone may increase risk of exposures for

• Form has U.S. address or address outside of treaty jurisdiction and is not “cured”

• Capacity line is blank or does not under-withholding or back-up withholding

• Failure to identify payments subject to withholding

indicate acceptable authority• TIN not provided where required (treaty

benefits)Form W 8IMY not associated withwithholding

• Controlled foreign corporations not compliant with information reporting rules, especially for U.S. payees

• Form W-8IMY not associated with withholding statements

• Form W-8IMY not associated with documentation for beneficial owners


• Invalid treaty claims

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