What are Form 1042-S Exemption Codes?

What Are Form 1042-S Exemption Codes?

Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, is used to report certain U.S.-sourced income paid to foreign persons and the amount of tax withheld. Two important boxes on this form are Box 3a (Chapter 3 Exemption Code) and Box 4a (Chapter 4 Exemption Code). These boxes indicate whether the recipient qualifies for an exemption from withholding under Chapter 3 (Withholding on Payments to Foreign Persons) or Chapter 4 (FATCA Withholding).

When completing Form 1042-S, withholding agents must enter the correct exemption code if an exemption applies. If no exemption applies, the boxes are left blank or mentioned as “00.”

Chapter 3 Withholding on Payments to Foreign Persons

Chapter 3 withholding rules apply to U.S.-sourced income paid to non-U.S. persons (foreign individuals, corporations, partnerships, etc.). The standard withholding rate is 30%, unless an exemption or tax treaty reduction applies.

Box 3a is used to report why the payment is exempt from Chapter 3 withholding.

Code 01: Effectively Connected Income (ECI)

If the income is effectively connected with a U.S. trade or business, it is subject to taxation at regular U.S. income tax rates instead of being withheld at source. The recipient must also provide Form W-8ECI to the withholding agent.

Code 02: Exempt Under Internal Revenue Code (IRC)

Used when a payment is exempt from withholding under a specific section of the Internal Revenue Code, but does not qualify under other Chapter 3 codes.

Code 03: Income Is Not From U.S. Sources

Used when the payment is from a foreign source and not subject to U.S. withholding.

Code 04: Exempt Under Tax Treaty

Used when a tax treaty allows for a reduced rate or exemption. The recipient must provide Form W-8BEN or W-8BEN-E.

Code 05: Portfolio Interest Exempt Under IRC

Used for qualifying portfolio interest payments, typically on registered corporate or government bonds.

Code 06: Qualified Intermediary (QI) That Assumes Primary Withholding Responsibility

Used when a QI takes full withholding responsibility under an IRS agreement.

Code 07: Withholding Foreign Partnership (WFP) or Withholding Foreign Trust (WFT)

Used when a WFP or WFT acts as a withholding agent on behalf of its beneficiaries or partners.

Code 08: U.S. Branch Treated as a U.S. Person

Used when a U.S. branch of a foreign FI elects U.S. person treatment for tax purposes.

Code 10: Qualified Intermediary (QI) Represents That Income Is Exempt

Used when the QI does not assume withholding responsibility but certifies the income is exempt.

Code 11: Qualified Securities Lender (QSL) That Assumes Primary Withholding Responsibility

Used when a QSL takes responsibility for substitute dividend withholding and provides Form W-8IMY.

Code 12: Payee Subject to Chapter 4 Withholding

Used when a payment is already subject to Chapter 4 (FATCA) withholding and not Chapter 3.

Code 22: Qualified Derivatives Dealer (QDD) That Assumes Primary Withholding Responsibility

Used when a QI acts as a QDD responsible for dividend equivalent withholding.

Code 23: Exempt Under Section 897(l) (Qualified Foreign Pension Fund)

Used when distributions are made to a qualified foreign pension fund and exempt under IRC Section 897(l).

Code 24: Exempt Under Section 892 (Foreign Governments and International Organizations)

Used when foreign governments or eligible international organizations are exempt under IRC Section 892.

Chapter 4 FATCA (Foreign Account Tax Compliance Act) Withholding

Chapter 4 withholding applies under FATCA and primarily targets foreign financial institutions (FFIs) and certain non-financial foreign entities (NFFEs) that do not comply with FATCA reporting requirements. The standard FATCA withholding rate is 30%.

Box 4a is used to report why the payment is exempt from Chapter 4 withholding.

Code 13: Grandfathered Payment

Used for payments under agreements executed before July 1, 2014, exempt from FATCA withholding.

Code 14: Effectively Connected Income (ECI)

Used when income is ECI and taxed at regular U.S. income tax rates. Form W-8ECI is required.

Code 15: Payee Not Subject to Chapter 4 Withholding

Used for payments not subject to FATCA due to the payee’s classification or during the grace period.

Code 16: Excluded Nonfinancial Payment

Used for nonfinancial payments like wages, leases, or service payments that are not subject to FATCA.

Code 17: Foreign Entity That Assumes Primary Withholding Responsibility

Used when a QI, WP, or WT agrees to assume FATCA withholding responsibilities.

Code 18: U.S. Payees of a Participating FFI or Registered Deemed-Compliant FFI

Used for U.S. account holders of compliant FFIs. Not subject to FATCA withholding but reportable income.

Code 19: Exempt from Withholding Under an Intergovernmental Agreement (IGA)

Used when the payment is exempt under an IGA between the U.S. and the payee’s country.

Code 20: Dormant Account

Used for payments allocable to dormant accounts per FATCA rules.

Code 21: Other Payment Not Subject to Chapter 4 Withholding

General code for non-withholdable payments not covered by other exemptions (e.g., return of capital).

File Form 1042-S Online with Tax1099

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