Nonqualified Intermediary Frequently Asked Questions
Reporting Obligations of Nonqualified Intermediaries and Flow-Through Entities
Question 1: We are a withholding agent. One of our clients, a nonqualified intermediary (“NQI”), has not provided us with any supporting documentation on its client/beneficial owners or withholding/allocation statements. How should we report this client at the end of the year?
Answer 1: As a withholding agent, we need to:
- Apply the presumption rules to determine the appropriate withholding rate. See Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities.
- Issue a Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding, to the NQI indicating payments made to “Unknown Recipients,” by putting code 20 in box 13b and complete boxes 17 through 20 with the information on the NQI, and file a copy of the form with the IRS (electronically, if required).
- Provide Form 1042-S to the NQI by March 15.
Question 2: We are an NQI and have received a Form 1042-S from our custodian showing payments made to an “Unknown Recipient” in box 13b. Do we have any further reporting obligations?
Answer 2: Yes, as an NQI we must send information returns to our clients that receive U.S. source income payments. Specifically, for each type of income received, we must issue a Form 1042-S to each non-U.S. resident client and a Form 1099 to each U.S. resident client. We must also submit the appropriate copies of those forms to the IRS (and do so electronically if we are filing more than 250 forms). We must also complete and submit a Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, to the IRS. Penalties apply for failure to comply under sections 6721 and 6722 of the Code. For additional information regarding the reporting obligations and the penalties applicable in the event of failure, see Treasury Regulation § 1.1441-1.
Question 3: We are an NQI and have partially disclosed our beneficial owner clients to our custodian withholding agent. What are our obligations?
Answer 3: For the disclosed clients, our custodian withholding agent must, for each type of income, issue the applicable Forms 1042-S to non-U.S. residents and Forms 1099 to U.S. residents. For the non-disclosed portion of our clients, the custodian withholding agent should apply Answer 1 above. We must apply Answer 2 above for our non-disclosed clients, but note that line 61 of the Form 1042 that we submit to the IRS should only reflect the number of forms that we produced to avoid double reporting.
Question 4: Are there any known instances when an NQI does not have reporting responsibilities?
Answer 4: No. An NQI must at least report tax status and allocation information on his payees to the upstream withholding agent. If the NQI has disclosed all of its beneficial owner clients with U.S. source income to its custodian withholding agent, and the USWA has provided the required Form 1042-S or Form 1099, as applicable to the beneficial owners, then NQI would have no further reporting obligations.
Question 5: We are a flow-through entity and we have received a Form 1042-S from our withholding agent. According to this form, however, the withholding tax has not been deducted. Do we have any responsibilities in this case?
Answer 5: We must contact our withholding agent to find out if the withholding tax has been deducted and deposited with the IRS and was erroneously not reflected on the Form 1042-S we received. If the withholding agent has failed to apply the necessary withholding, we must apply the withholding and remit the withheld amount to the IRS in a timely fashion. For reporting responsibilities of the NQIs, see Answer 2 above.
Question 6: We are an NQI and have not disclosed our clients with U.S. source income to our withholding agent. We have not contacted the IRS. How would the IRS ever know if we did not file the requisite returns?
Answer 6: It depends of whether you provided an accurate W-8 to the upstream withholding agent. If you claimed to be a beneficial owner on Form W-8BEN and the withholding agent did not identify this as false based on all information he has, you or both of you both become liable for the correct tax and penalties whenever an audit uncovers your true status. If you provided a W-8IMY to the upstream withholding agent and no information on your clients, the withholding agent should treat you in accordance with Answer 1, withholding 30%. You are required to provide the documentation according to Answer 2.
Question 7: What happens if an NQI or flow-through entity fails to file and report?
Answer 7: The regulations require that whenever a Form 1042-S is known to be required or incorrect, a correct one must be filed. This usually requires an amended Form 1042 as well. Failure to do this could be intentional or unintentional, with reasonable cause or without. The regulations provide a range of penalties for NQIs that fail to provide information returns to their clients under sections 6651, 6656, 6662, 6721, 6722 and 6723 and others. Failures to file discovered on audit often results in prior and subsequent years being reviewed for similar failures. Separate penalties also apply for failure to file copies of those returns to the IRS. A third set of penalties apply for failure to use the correct transmission method when filing returns to the IRS. More information on these penalties may be found in the Instructions for Form 1042-S.