Time is Running Out for IRS Form W-8/1042 Voluntary Disclosure Program

As most local financial institutions with international clients have been made aware, the IRS is currently undertaking a review of withholding and information reporting on payments made to nonresidents of the U.S., as well as related policies and procedures implemented by financial institutions to ensure enforcement. Several financial institutions in Miami and New York have been or are in the process of being audited.

The IRS has not historically reviewed compliance in this area and, until recently, there was not much guidance. This situation has led to non-filing or incorrect filing of Forms 1042/1042-S, as well as incorrect, incomplete, outdated or missing Forms W-8.

Non-resident customers with an incorrect, incomplete, outdated or missing Form W-8 may be treated as undocumented U.S. customers. In this case, backup withholding would be required to be withheld at the current rate of 28 percent and remitted to the IRS. Income Tax Treaties in force between the U.S. and certain foreign countries may provide for a reduced rate of withholding, from the standard rate of 30 percent, on certain payments of U.S. source income to nonresident customers. However, if the Form W-8 is incorrect, incomplete, outdated or missing, the reduced treaty withholding rate would not apply. The risk of under-withholding and/or non-filing applies to custodial arrangements where the financial institution acts as an intermediary as well as to interest bearing deposits.

As of late, the IRS has conducted several seminars, including question and answer sessions, and has made itself available in order to provide clarification and guidance on the topic.

Financial institutions should conduct a self review in order to assess their compliance with these withholding and information reporting rules. They should also evaluate their account opening and compliance policies and procedures, as well as training sessions for account officers, in order to ensure that compliance with these withholding and reporting rules is being met.

While there are various ways to correct problems that have been found after a self review, the only sure way to avoid any under-withholding and/or non-filing penalties is to apply for a Voluntary Disclosure Program (“VCP”). Under a VCP, a self audit is conducted and the results are presented to the IRS in a pre-submission meeting. The IRS will allow the institution to remedy any noncompliance with withholding, reporting and/or implementation of policies and procedures. Taxes and interest relating to any under-withholding that has not been “cured,” if applicable, will be required to be paid to the IRS by March 31, 2006. In certain instances, the IRS is granting an extension of time to complete the VCP until June 30, 2006.

Once a VCP submission has been made, the IRS is precluded from conducting an examination of this topic for the years covered by the VCP submission until the time when the VCP ends. The IRS has indicated that although it is not precluded from examining all years not closed by the statute of limitations, after the VCP ends, it will look favorably upon taxpayers whose VCP submission it reviewed and approved.

If you have any questions on this topic or would like assistance in conducting a self review or filing a submission for the VCP, please contact Raul Incera at rincera@mbafcpa.com.