1042-S Withholding: Rules, Rates & Compliance for U.S. Payers Handling Payments to Foreign Persons

What happens when your business expands overseas? That’s an exciting achievement because it opens new markets, gives you access to hire diverse talent, and creates new growth opportunities. When you collaborate with partners who are not U.S. residents, these connections come with the responsibility of cross-border compliance.

Payments to foreign persons that are U.S.-source amounts are generally subject to withholding and Form 1042-S reporting. Form 1042-S reports U.S.-source amounts paid to foreign persons (individuals and entities) and any tax withheld. Let’s understand more about this form and the intricacies involved in filing this form.

What is Form 1042-S and Why Does it Matter?

Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, is used to report US-source income for foreign persons. Common reporting types of payments include interest, dividends, royalties, scholarships, prizes that may be awarded, and certain payments for services.

Form 1042-S is used to report amounts subject to Chapter 3 (NRA withholding) or Chapter 4 (FATCA withholding), such as U.S.-source FDAP income (dividends, interest, royalties, etc.), taxable scholarships or fellowships, and payments for services to foreign independent contractors. Most employee wages are instead reported on Form W-2, except in limited treaty-exempt cases.

This reporting is important so that the U.S. Internal Revenue Service (IRS) collects the correct amount of withholding tax on U.S.-source payments.

Important: For payers, it is important that they comply with the applicable 1042-S withholding rules and the 1042-S reporting requirements to avoid substantial penalties. Penalties can vary $60, $130, or $340 per form depending on lateness. For intentional disregard, $680 per form (or 10% of gross, if larger).

Who Must File and Withhold Form 1042-S?

A withholding agent can be U.S. or foreign—any person that has control, receipt, custody, or payment of U.S.-source amounts to a foreign person. So, any withholding agent (including the US business, financial institutions, partnerships, nonprofits, and government agencies that make the payment) is required to file Form 1042-S and withhold required taxes.

The payee is considered the foreign beneficiary of the income, regardless of whether the payment is made directly to the foreign person or through a third party, provided that the U.S. payer controlled the flow of funds. Payments made to U.S. entities and individuals are not subject to these filing requirements; rather, the payer will issue Form 1099 or W-2.

When Does 1042-S Withholding Apply?

The withholding tax rate for a non-resident is 30%, or a reduced treaty rate where applicable, and with the proper documentation.

Below are some important points to be remembered:

• Default withholding of 30% applies to the vast majority of U.S.-source income.
• Reduced treaty rates will apply using supporting documents, like valid W-8BEN or W-8BEN-E forms.
• The types of income that are subject to withholding are FDAP taxation (dividends, royalties, and rents), scholarships and fellowships, and substitute payments.
• For effectively connected income (ECI) with a U.S. trade or business, no Chapter 3 withholding applies; however, you must still report it on Form 1042-S using Chapter 3 exemption code “01” (Box 3a), supported by a valid Form W-8ECI (including the payee’s U.S. TIN).

How to Calculate Form 1042-S Withholding?

The withholding amount depends on several factors, like the type of income being paid, like royalties, dividends, or compensation for services, whether the recipient is eligible for reduced tax rates under a tax treaty, and even the currency in which the payment is made.
So, when you want to determine how much tax to withhold and report on Form 1042-S (non-treaty), you can use this simple formula:

Tax to Withhold: Gross payment × Applicable 1042-S Withholding Tax Rate

The default is 30%, but a tax treaty can reduce it. So, for example, if a gross payment to a foreign consultant is $10,000, and the withholding tax is 30% (no treaty claim), the tax withheld to claim will be $3,000 ($10,000 x 30%). This means the business remits $3,000 to the IRS and pays $7,000 to the consultant.

However, the U.S. has income tax treaties with different countries that reduce (or sometimes eliminate) the standard withholding tax rate on certain types of income paid to foreign entities. That’s why businesses should determine country eligibility and apply only the applicable reduced rate if eligible.

Also, for treaty rates, proper documentation is required. Ensure that the recipient provides a valid Form W-8BEN (individual) or W-8BEN-E (entity) to claim the treaty benefits. If no form is provided or it is incomplete or incorrectly filled out, the withholding agent must apply the full 30% rate, even if a tax treaty exists.

Now, if a single payee receives more than one type of income, for example, both consulting fees and royalties, then each type of income must be reported separately. Each income type (or rate) must be reported on a separate Form 1042-S.

While the payments are made in foreign currency, for reporting purposes, they need to be converted into U.S. dollars. Amounts on Form 1042-S must be reported in U.S. dollars; convert foreign-currency payments to USD using a consistent method and keep documentation of the rate used.

How to File Form 1042-S?

Following IRS 1042-S instructions for payers can help ensure payments to foreign persons are reported correctly. Here are the steps given below:

• Document Collection: Get the necessary forms, like W-8BEN or W-8BEN-E forms, completely and correctly filled out by the foreign party.
• Income Type Identification: Each type of income has a specific code — e.g., Code 06 (dividends), Code 18 (compensation for dependent personal services), Code 15 (pensions/annuities/insurance premiums), and Code 16 (scholarships/fellowships). Most employee wages are reported on Form W-2; Code 18 on 1042-S applies only in limited treaty-exempt cases
• Tax Calculation: Apply the appropriate tax rate. A 30% by default on most U.S.-source FDAP income, or a reduced treaty rate if a valid W-8 form is provided. If the income is connected to U.S. trade and supported by W-8ECI, then no withholding is required.
• Fill the Form: When filling the form, ensure to fill out the key sections, including Box 1 (Income Code), Box 2 (Gross Income), Box 3a (Chapter 3 exemption code), Box 3b (Chapter 3 tax rate), and Boxes 7a–11 (tax amounts/credits)—7a federal tax withheld; 8 withholding by other agents; 9 overwithheld amount repaid; 10 total withholding credit; 11 tax paid by withholding agent.
• Form 1042: File the annual Form 1042 (tax return) every year you’re required to file 1042-S. If you paper-file Forms 1042-S, you must also transmit them with Form 1042-T.

1042-S Filing Deadlines

Here are the important Form 1042-S filing deadlines:

• March 16, 2026 is the last date to file Form 1042-S with the IRS and send copies to recipients (March 15 is a Sunday, so the due date moves to the next business day).
• Need more time to file? File Form 8809 by the due date to get a 30-day extension. This extends IRS filing only.
• Need more time to send recipient copies? Submit Form 15397 (fax) by the original furnish date to request a one-time 30-day extension for recipient copies.
• Remember that e-filing is required if your business files 10 or more information returns for the year.

Also, the fines for late filing can escalate quickly; hence, it is best to file at the earliest. If the IRS decides that you have intentionally ignored filing requirements, then the penalty is much harsher.

Common Mistakes to Avoid

In the IRS 1042-S instructions for payers and their responsibilities and obligations, they stress that the most relevant aspect of nonresident alien withholding tax reporting is accuracy. Missing the filing deadline for Form 1042-S, or reporting errors, can result in penalties.

Filing Form 1042-S is complex because of strict compliance rules and varying tax treaties, so errors are common. But these errors are a straight invitation to penalties unless you have a valid reason. So, it’s best to avoid making mistakes by acknowledging the errors made by businesses:

• Treating a U.S. person or entity for foreign or vice versa leads to incorrect withholding and reporting. That’s why you should always verify the status with proper documentation. Use W-8 for foreign entities and W-9 for U.S..
• Ensure the foreign party provides a valid W-8 form, and outdated, unsigned, or incomplete forms with missing information are not acceptable. In such cases, the withholding agent is required to apply the default 30% rate; otherwise, the agent might face compliance risk during an IRS audit.
• Different incomes have different income codes, and accordingly, the withholding rate is applied. Wrong code or applying the incorrect withholding rates may lead to reporting mismatches and compliance risks.
• The withholding agent (U.S. or foreign) must file a separate Form 1042-S for each recipient and, if needed, for each income type/rate.
• Also, withholding is always made on gross income, which is the full payment made before expenses or any deductions. Reporting withholding on the net income amount is a frequent error that requires correction.

Real-Life Scenarios

Utilizing the IRS 1042-S instructions for payers in practical situations helps to ensure compliance with nonresident alien withholding tax requirements and proper reporting before the Form 1042-S’s due date.

Let’s understand more about scenarios to get an idea, and accordingly, you can file the Form 1042-S:

• A foreign contractor who earned $4,000 from a U.S. client for design services is subject to 30% withholding unless a treaty reduces the rate. So, this means, $1,200 remits to the IRS, and $2,800 is paid to the foreign contractor.
• A UK company that received $15,000 in royalties, and with a valid W-8BEN-E, the company benefits from a 0% treaty rate, so that a 1042-S can be filed with no withholding. The company receives the complete $15,000 without any deductions.
• A nonresident student receives a $6,000 stipend, but that’s not for tuition; hence, a withholding tax rate will be applied. If it had been for tuition, required fees, or books, then it would have been exempt. IRS requires 14% withholding on non-qualified scholarship or fellowship income (such as stipends or living allowances) paid to nonresident aliens on F, J, M, or Q visas. Qualified scholarships covering tuition, required fees, and supplies are exempt from withholding.
• For a non-gambling prize of $2,500 paid to a foreign individual, report income code 23 (Other income) and withhold 30% by default ($750), unless a treaty reduces it. If it’s gambling winnings, report income code 28; the default 30% applies unless a treaty provides a lower rate.
• If a foreign investor receives $20,000 in dividends, then normally it comes under 30% withholding tax rate. However, since the investor is a resident of Canada with a tax treaty, the withholding tax rate applied would be 15%. Hence, $3,000 is withheld under the income code 06 (dividends paid by U.S. corporations).

FAQs

1. What is the default withholding rate?

The withholding tax rate for the 1042-S is, in general, 30%, unless there is a reduced rate according to a tax treaty.

2. Do payers have to file if there is no tax withheld?

Yes. If the payment is U.S.-source income to a foreign person, Form 1042-S must still be filed even if no U.S. tax was withheld.

3. Can a U.S. citizen receive a 1042-S?

No, according to the IRS’s 1042-S instructions for payers, U.S. persons must receive a 1099 or W-2.

4. What is the deadline?

The deadline for filing Form 1042-S is March 16, 2026 for both the IRS and the person receiving the payment.

5. What does a payee need for treaty rates?

A payee must have a valid Form W-8 to comply with 1042-S withholding regulations and claim a reduced rate.

6. Can one person have more than one 1042-S?

Yes, when reporting various types of U.S. source income to foreign persons or using different rates.
Ensure full compliance with 1042-S withholding rules by following the IRS 1042-S instructions for the payer, protect your business from penalties, and streamline your reporting process.