Caution: U.S. Nonresident Tax Withholding May Apply to Payments of Certain Types of U.S. Source Income to Foreign Persons

Blog
October 11, 2012

Payments of certain types of U.S. source income to foreign persons are subject to U.S. nonresident tax withholding, which generally requires 30% gross withholding at source.  The types of U.S. source income subject to U.S. nonresident tax withholding include interest, dividends, rents, royalties and compensation for services performed by a foreign person in the United States as a consultant or independent contractor.

The U.S. person making the payment must file the Forms 1042 and 1042-S to report the U.S. nonresident tax withholding and to claim any exemption from the requirement to withhold at the 30% tax rate.  A reduced rate of U.S. nonresident tax withholding could apply under a U.S. tax treaty with the foreign payee’s country of citizenship.  The foreign payee must obtain a U.S. taxpayer identification number to claim a reduced rate of U.S. nonresident tax withholding, which is reportable on the Form 1042-S.  The U.S. person making the payment must obtain the applicable Form W-8 from the foreign beneficial owner of the payment (usually the foreign payee).  The Form W-8 certifies the status of the foreign beneficial owner of the payment as a foreign person.  A foreign person working as an independent contractor in the United States should provide the Form 8233 to claim a treaty exemption.

There are specific source rules that determine if payments of certain types of income are considered to be U.S. source income subject to U.S. nonresident tax withholding:

  • Payments as compensation for personal services are sourced to the country where the services are performed.
  • Payments for interest are sourced to the residence of the payer.
  • Payments for dividends are sourced to the country where the corporation is incorporated.
  • Payments for rents are sourced to the location of the property.
  • Payments for royalties for the use of intangible property are sourced to the country where the property is used.
  • Payments for royalties related to natural resources are sourced to the location of the property.

See IRS Publication 519 for more information.

The following are examples of different types of payments that are subject to U.S. nonresident tax withholding.

  • Compensation for Services – U.S. company compensates a foreign person for the performance of services in the United States as an independent contractor.
  • Interest – U.S. person pays interest on a loan obligation owing to a foreign person.
  • Dividends – U.S. corporation pays a dividend to a foreign shareholder.
  • Rents – Foreign person owns U.S. rental real property and receives rental income payments.
  • Royalties – U.S. company licenses software from a foreign company and the services or products which integrate the licensed software are sold or distributed in the United States.  The U.S. company’s payments of royalties to the foreign company for the use of the software are U.S. source income subject to U.S. nonresident tax withholding.

For more information, please contact our international tax advisor at 301.231.6200.