As we approach the year end, there is an important filing change for tax year 2023 that applies to any business that pays US sourced income to foreign persons. If your organization pays foreign individuals or entities and files the 1042-S form – you are also required to file form 1042, which is the tax return “cover letter” or consolidated statement of all payments and withholding to these foreign individuals. An important distinction between the two forms is that 1042-S forms are filed with the IRS and sent to individual payees, while the 1042 return is only filed with the IRS. Another important point is that the 1042 return is typically required whether you withheld taxes from your foreign payees or not.
Historically, the IRS has not supported the electronic filing of Form 1042. However, starting with tax year 2023 reporting, the IRS will now require financial institutions and organizations that file more than 10 information returns for the calendar year to file from 1042 electronically. Let’s take a quick look at what this means.
Who will be impacted?
Any business/firm/withholding agent that is required to issue at least 10 information returns (including Forms 1099, W-2, 1042-S, etc.) will need to comply with the new electronic filing requirements. However, if you are doing business as an individual (Sole Proprietorship), estate or trust, this change does not apply to you.
What is this new requirement all about?
In addition to the fact that the 1042 is a complex return, the electronic filing requirement may be difficult for many businesses to implement. First, the electronic filing of the 1042 must be completed through the IRS Modernized e-File (MeF) system. Second, since Form 1042 could previously only be filed on paper, businesses will now need to find a system/provider that is able to support electronic filing of Form 1042 following the IRS’s specific layouts. If you are going to try and handle this on your own, the individuals within your organization that handle the reporting will need to secure proper credentials and approval to file electronically (more info on that later in this blog). Lastly, as part of this update, businesses are also required to file corrections in the same method in which the original version was filed. Similar to the new eFile requirements for most 1099, W-2 and 1095 series forms, any changes/corrections to Form 1042, must also be submitted electronically if the original version was filed electronically.
What does this mean for the 945 or other 94x series forms?
The 945 and other 94x series forms are not required to be filed electronically as part of these changes. However, when determining whether the aggregate of 10 forms threshold has been met to require electronic filing, a business must include the 94x series of forms in the count.
Why is electronically filing Form 1042 such a challenge?
Filing Form 1042 electronically must be completed through the IRS Modernized e-File (MeF) system. Unlike the File Information Return Electronically (FIRE) System for submitting series 1099 and 1042-S forms, MeF requires additional background check requirements and a longer application process. The process for completing and submitting your application to the IRS MeF system through the IRS e-Services system can be a long process that could take 45 days or more. To complete the application, you will be required to assign two responsible officers to own your account and process. These individuals must be a licensed professional in one of the following areas: attorney, bank official, CPA, EA or an officer of a publicly owned corporation. If they don’t meet one of these criteria, they will be required to go through an extensive background check, which includes a fingerprinting process. And, once your organization is approved, there is still the matter of building and testing an MeF transmittal with the IRS to obtain final approval to file.
Why is this such a big deal?
The 1042 Form has been identified by the IRS as a Tier 1 audit. Transactions involving U.S. income and non-U.S. payees have been a Tier 1 audit focus for the IRS since the Foreign Account Tax Compliance Act (FATCA) was implemented. Per IRS guidelines, failing to file Form 1042 electronically can trigger an IRS examination/audit of all transactions involving non-U.S. payees. Make sure to consult your tax advisor on the specific risks/implications of not filing the 1042 withholding return for your organization.
How eFileMyForms can help?
While eFileMyForms continues to support electronic filing of the 1042-S form to foreign based payees, the service will not directly support the filing of the associated 1042 withholding return for tax year 2023. Fortunately, our parent company, Sovos has competed the rigorous approval process and is one of the few IRS approved Modernized e-File (MeF) Business Providers for 1042 returns. If your organization needs to electronically file the 1042 tax return, we encourage you to learn more about this turnkey service by visiting the form 1042 solution page.
Update:
In a late breaking change, the IRS released Notice 2024-26 announcing a delay in the new requirement to electronically file Form 1042 (the Annual Withholding Tax Return for U.S. Source Income paid to foreign payees) for 2023 transactions with the IRS’s Modernized e-File (MeF) system.