US IRS delays Form 1042 electronic filing requirement for US and foreign withholding agents

• The relief is welcome to withholding agents while they figure out how to comply with the new e-filing requirements.
• Withholding agents' main concerns were the limited number of approved e-file providers for Form 1042, as well as difficulty using the current IRS "schema and business rules" to file certain Forms 1042 electronically.

In Notice 2024-26 (pdf) (issued February 27, 2024), the IRS exempted US and foreign withholding agents from electronically filing Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, for calendar year 2024.

The electronic filing requirement is delayed as follows:

This relief does not apply to Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding.

Background

Form 1042 is an annual information return submitted by withholding agents to provide, among other information, details on (1) withholding tax liabilities, (2) deposits for non-resident alien (NRA) withholding under IRC Sections 1441 through 1443, and (3) Foreign Account Tax Compliance Act (FATCA) withholding under IRC Sections 1471 through 1473. The return has historically been a paper ("wet ink" signature) mailing to the IRS. For each calendar year, Form 1042 is due by March 15th of the succeeding year, although a six-month extension is possible.

In February 2023, the Treasury Department and the IRS published final regulations on electronic filing (e-filing) requirements (see Tax Alert 2023-0356). The regulations require the following types of withholding agents to e-file Form 1042 and Form 1042-S starting with their 2023 reporting (to be filed with the IRS in 2024):

• Financial institutions
  
  
• Partnerships with at least 100 partners
  
  
• Any entity (other than a trust or estate) that files 10 or more tax returns of any type (e.g., information returns, income tax returns, employment tax returns, excise tax returns, etc.) for that reporting year

Under the final regulations, a withholding agent that fails to file electronically, when required, is deemed to have failed to file the return(s) and is subject to the applicable IRC Section 6651 failure-to-file penalties.

Submission requirements

Forms 1042 that are required to be filed electronically must be submitted through the IRS Modernized e-File (MeF) process (utilizing an XML schema) by IRS-approved providers, who must go through a formal application and approval process.

EY observes: As the list of affected withholding agents is broad, a majority of withholding agents would need an IRS-approved provider to e-file their Forms 1042. Smaller non-financial entities might also need to e-file based on their aggregated total of all IRS returns filed. The small number of IRS-approved providers, however, could be insufficient to meet the increased demand for e-filing. Affected withholding agents that could engage (or further engage with) one of the approved providers typically face a time-consuming process.

Notice 2024-26 relief

Notice 2024-26 administratively exempts all withholding agents from the e-filing requirement for 2023 reporting. Foreign withholding agents get an additional year of relief and are exempt from the e-filing requirement for both 2023 (to be submitted to the IRS in 2024) and 2024 reporting (to be submitted to the IRS in 2025).

The relief is automatic (i.e., no further action is needed to be taken by the withholding agent). In addition, Notice 2024-26 will not treat a Form 1042 that is timely submitted on paper as a failure to file.

The relief under Notice 2024-26 does not appear to extend to withholding agents filing Form 1042-S. As such, those agents must electronically file Form 1042-S using the IRS's FIRE system.

EY observes: For 2023 reporting, withholding agents may either continue filing Form 1042 through paper or use an e-file provider. For those filing before the March 15, 2024 deadline or claiming credits for tax withheld by others, submitting a paper return may be the most viable option, as e-file providers are limited and the process for claiming credits is complex. Withholding agents that have filed a six-month extension (with a September 15, 2024 deadline) may want to evaluate and consider the possibility of e-filing as it could expedite processing time for refunds and credits as well as eliminate the concern of a paper filing getting lost in the mail.

According to Notice 2024-26, the IRS received industry feedback and concerns, primarily on the limited number of approved providers, necessary system upgrades, and authentication requirements for non-US persons. One of the industry concerns not referenced in Notice 2024-26 is the new process for substantiating withholding performed by an upstream withholding agent (e.g., a Qualified Intermediary completing Form 1042, Line 67 to take a credit for amounts withheld). Previously, copies of the Forms 1042-S (or 1099) showing the upstream withholding were attached to the paper Form 1042 submission. When filing Form 1042 electronically, withholding agents would have to transcribe information from the Forms 1042-S (or 1099) received as part of the XML schema. The impact would primarily be on Qualified Intermediaries, so the additional year of e-filing relief for non-US persons will be helpful while they figure out how to comply with this new requirement.

Contact Information

For additional information concerning this Alert, please contact:

Financial Services Organization

• Tara Ferris
• Jonathan Jackel
• Ryan Blewitt

Exempt Organization Tax Services

• Stephen Clarke
• Lauren E. Bennett
• Morgan Moran

Published by NTD’s Tax Technical Knowledge Services group; Andrea Ben-Yosef, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.