Who needs to receive a 1042-S?

Tax law and immigration law define residency differently, so you need to determine whether a worker from a foreign country is considered a resident or nonresident alien for tax purposes. Those subject to tax reporting include nonresident aliens and foreign trusts, corporations and estates. Any employee or contractor who’s not considered a resident of the United States needs to receive a 1042-S, which reports their compensation for the previous year. This form serves only to report your employee’s income to the IRS and isn’t used to report withholding.

Even if you’ve not withheld any taxes throughout the year, you’re required to report income. In instances where you withheld taxes, you’re required to provide a W-2 as well so your employee can complete a tax return. Foreign workers who received any of the following forms of compensationneed to receive 1042-S forms.

• Scholarships
• Stock dividends from businesses based in the United States
• Income on real estate transactions
• Income from pensions
• Royalties
• Insurance benefits
• Gambling profits
• Salaries
• Hourly pay

You must issue a separate 1042-S for each type of compensation you’ve provided. For example, if you’ve granted a foreign employee a college scholarship to study in the United States, offered health insurance and paid your worker a salary, you’d be required to file three forms.

What is the difference between Form 1042 and 1042-S?

If you’re employing a foreign worker, you have the option to file a 1042 or a 1042-S. The form that you file depends on whether you withheld taxes. If you did withhold taxes, you need to use a 1042 to report your withholding to the IRS for that individual so the IRS knows how much they’ve paid in taxes. A 1042-S is used to report compensation where you’ve not withheld taxes, such as for benefits or wages that were tax-exempt due to a tax treaty between the United States and your employee’s home country.

You don’t need to send a 1042 to your employee because the necessary withholding information for tax purposes will be on the W-2 you provide. In that case, you’d send a 1042 to the IRS only. You’re required to send a 1042-S to the IRS and your employee, and it must be filed with a Form 1042-T.

What is a tax treaty?

The IRS requires all workers, whether residents or nonresident aliens, to pay income taxes on any form of compensation they earn while present in the United States. The government has agreements with foreign countries that provide tax exemptions to workers for those countries. In many cases, a portion of the employee’s wages may be exempt from taxes due to a tax treaty, but they’re required to pay taxes to the United States on anything that is earned in addition.

When you’re determining whether to withhold taxes from a foreign worker’s pay, you need to consider whether their home country has a tax treaty and what its provisions are. For example, if your employee is from a country where the first $7,000 of income is exempt from U.S. taxes, you would file a 1042-S for up to $7,000 and then provide a W-2 after withholding tax for the amount earned greater than $7,000 that year.

FICA and Medicare exemptions

If an employee has nonresident status because they’re in the country temporarily on a work permit or visa, you’re not required to withhold FICA or Medicare from their wages. The amount of time an individual is staying in the United States has an impact on this withholding requirement. Once someone has been living in the United States for more than five consecutive years, their status changes to a resident for tax purposes.

This means that you’re required to begin withholding FICA and Medicare once your employee’s status changes. Some employees may continue to be exempt from these deductions, such as students from foreign nations. Instead of being exempt due to their foreign work status, they would be exempt under a Student FICA exemption. Knowing this difference can help you avoid filing tax forms incorrectly.

How to file Form 1042-S

If you’re required to report compensation for tax withholding, you need to file a 1042 instead. If the reported income is exempt from taxes, you need to file one 1042-S and 1042-T for each type of income you’re reporting. This can be very complicated when you’re providing compensation to an employee in the form of insurance, retirement benefits and other components of a benefits package. Here is how to fill out each form:

• Provide the income code for the type of income you’re reporting. This is the most important part of the form, and you must provide the right code.
• Fill in the gross income with the total income made before any deductions for insurance, retirement accounts or additional voluntary deductions.
• Enter Chapter 3 if the form is for an employee and Chapter 4 if you’re filing the form for a foreign financial institution.
• If you’re not withholding any taxes on your employee’s income, you need to provide an exemption code. You can find the correct code by reading through IRS Appendix B on the form. There are 23 codes for you to choose from, so make sure you use an accurate exemption code.
• Income codes 16-20 have a withholding allowance. These apply for compensation in the forms of scholarships, fellowship grants, compensation for personal services, earnings for teaching and income earned duringon-the-jobtraining.
• When the withholding credit and tax withholding boxes are both filled in with $0, you’re not required to send the form to the IRS, but you still need to provide it to your employee for their records. When this is the case, your employee doesn’t need to include the form when filing an income tax return either.
• Find the right country code from theIRS’s list of foreign countries on the IRS website. If you’re unable to find the country on the list, that’s okay. You simply enter OC in that instance.
• UseIRS Appendix Bto find your employee’s recipient status code and enter it in the appropriate box.
• If you’re required to withhold state income taxes for your employee, enter the amount of withholding in the appropriate box.
• Next, you provide the state tax number for your employee.
• Fill in the state name, and the form should be completed at this point.

Make sure that you’re aware of whether the form needs to be filed with the IRS because failure to file required tax forms can result in penalties and fines. Remember that you need to provide a 1042-T with every 1042-S that you file with the IRS. If you’ve withheld taxes, make sure to complete a W-2 for your employee and file a 1042, if required.

Who can assist with filing Forms 1042, 1042-S and 1042-T?

If all of this seems confusing to you, you’re not alone. Filing the necessary tax forms for foreign employees can be time-consuming and frustrating. Many businesses choose to outsource human resource functions and tax reporting instead of risking filing the forms inaccurately. If you need assistance with tax forms and payroll, you can consider the following options:

• Visit the IRS website at IRS.gov for information about tax forms and filing requirements.
• Hire a tax account or CPA to help with tax withholding and reporting.
• Use an HRIS system to help manage your payroll and determine the correct withholding and reporting requirements.
• Outsource payroll to another business that can also assist in tax reporting and form filing.

An HRIS system allows you to manage multiple human resources functions. In addition toassistingyou with payroll and managing employee benefits, it can help with data management, recruiting, managing workflows, onboarding programs and organizational management. Many small or medium-sized businesses are turning to these systems because it’s too time-consuming to perform these functions themselves and too expensive to hire human resources staff.

You should always consult with a tax accountant or attorney to make sure that your HRIS system’s payroll and tax reporting functions are compliant so you avoid financial penalties and legal troubles with the IRS. If you really want to ensure accuracy, you can consult with or hire an HR business partner.

Whenever you provide compensation to a foreign employee or foreign business, make sure that you file the appropriate tax documents each year so that the IRS has a record of their compensation and income. Even if you haven’t withheld any taxes, you need to provide a 1042-S and 1042-T for each form of compensation you provided. Once you’ve done your part, it’s up to your employee or the foreign business to handle the rest.