Who this is for
- US corporations that paid interest, royalties, dividends or fees to a foreign parent, lender, investor or licensor without withholding
- US subsidiaries that never filed Forms 1042 and 1042-S, or filed them wrong
- Startups that paid or converted note interest for investors abroad without W-8 forms
- Server, power-equipment and chip companies with a parent or licensor outside the US
Not covered here
- Setting up withholding correctly from now on
- Transfer pricing studies and intercompany markups
- Sanctions screening of payees
- Drafting loan, licence or gross-up clauses (a legal task)
- Export controls on licensed technology, and customs
- The payee's own US or home-country return
We paid abroad and withheld nothing: who owes the tax?
The US company that paid owes it. As withholding agent, it is personally liable for the tax it should have withheld: 30% of the gross US-source payment, unless an exemption or a documented treaty rate applied, plus interest and penalties (Publication 515; section 1461).
If the company absorbs the tax instead of recovering it from the payee, the tax can grow to 42.86% of the amount paid (see the gross-up section below).
No US income tax treaty with Taiwan is in force; Taiwan is not on the IRS treaty list. A Taiwanese parent's interest, royalties and dividends bear the full rate. Other countries' treaty rates are in IRS Tax Treaty Table 1; a rate applies only with a valid W-8 claiming it. For the pending relief bill, see entering the US from abroad.
Several missed years, a late treaty claim or a parent that is also lender and licensor make a case complex. Gather loan and licence agreements, board minutes for distributions, bank wires, the intercompany ledger and every W-8 on file.
Which payments needed withholding, and which didn't?
US-source interest, royalties, dividends and service fees paid to a foreign person needed withholding (Publication 515):
| Payment | US-source when | Withhold? |
|---|---|---|
| Interest on a loan or note | A US corporation pays it | Yes, unless portfolio interest or a treaty applies |
| Royalties for patents, designs, know-how, or the right to copy, modify or distribute software | The property is used in the US | Yes, unless a treaty applies |
| Dividends | A US corporation pays them | Yes, on the whole distribution unless earnings and profits were reasonably estimated |
| Service fees | The work is performed in the US | Yes, unless documented as effectively connected |
| Service fees for work done abroad | Never | No |
Paying for copies of software, even for many users, is not a royalty unless it also grants the right to copy it for sale, change it or show it publicly. It is a sale or, if the seller keeps ownership, a rental, and rent for property used in the US can still need withholding (regulation 1.861-18).
A payment needs no cash. Netting against what the parent owes, paying the parent's creditor, or issuing stock for accrued interest all count (regulation 1.1441-2(e)).
Dividends: withhold on the whole distribution unless the company reasonably estimated its earnings and profits near the payment date (regulation 1.1441-3(c)). A first-year subsidiary's distribution can be partly return of capital; how much depends on its earnings and profits for the year.
Do service fees need withholding when the work was done abroad?
No. Fees for work performed outside the US are foreign-source: no withholding and normally no Form 1042-S (IRS). They still go on Form 5472.
Two traps:
- A "technical service fee" that also grants rights to designs, firmware or know-how used in the US is partly a royalty. Split the invoice by what it buys and where the work happened.
- Parent engineers working at a US data center earn US-source fees. Withhold unless the parent gave Form W-8ECI and reports the income on Form 1120-F. For the engineers, see sending employees to the US.
Gross up withholding tax, or have the payee pay it back?
Either; the cost differs. The ways to settle missed tax:
- This year's payments only: withhold the shortfall from later payments to the same payee, or from its property the company controls, before that year's Form 1042 due date without extensions (regulation 1.1461-2(b)). For this year's payments: March 15, 2027.
- The payee repays the tax under a written agreement: no gross-up.
- The company bears it. If that is extra income to the payee (a facts question, agreements included), grossed-up payment = amount paid ÷ (1 − rate). Box 2 of Form 1042-S shows the grossed-up amount; box 11 shows tax paid from the company's own funds (instructions).
- The payee pays its own US tax. The tax is collected once, but the company still owes interest and penalties (section 1463; payee's Form 4669, company's Form 4670).
Can we collect a W-8BEN-E after the payment?
Yes. A late W-8 counts from the payment date if it carries a signed affidavit that it was accurate then (regulation 1.1441-1(b)(7)):
| Form arrives | Also needed |
|---|---|
| Within 30 days | Nothing |
| 31 days to one year | Affidavit |
| More than one year | Affidavit plus documentary evidence of foreign status or treaty residence |
For an entity's treaty claim, the evidence is an official government document showing its name and principal office address in the treaty country (regulation 1.1441-6(c)(4)). A late W-8ECI's affidavit must also state that the payee reported the income on its US return, or will report it on a return not yet due. A W-8 stays valid through the end of the third calendar year after it was signed, unless facts on it change; a form that had expired on the payment date counts as no form (regulation 1.1441-1(e)(4)(ii)).
A Taiwanese parent's late W-8BEN-E does not lower the rate, since there is no treaty, but it supplies the status codes Form 1042-S needs. A treaty-country licensor can get the treaty rate if it is the beneficial owner, resident in that country, and meets the treaty's limitation on benefits article (regulation 1.1441-6(b)).
Is convertible note interest exempt as portfolio interest?
It can be. Portfolio interest is exempt when (Publication 515; regulation 1.871-14):
- the note is in registered form: the company or its agent records who holds it, and it changes hands only by reissue to the new holder or through a book-entry system;
- the holder owns less than 10% of the voting power;
- the interest is not contingent;
- the holder is not a bank lending in its ordinary business; and
- the company has the holder's W-8.
Ownership counts stock under section 318 as section 871(h)(3)(C) modifies it, and an option to acquire stock counts as owned (section 318(a)(4)), so a conversion right can push a holder over the line. Parent loan interest never qualifies: the parent holds 10% or more of the vote. A sister company that lends can count as owning the parent's stake too.
Portfolio interest and treaty rates remove only this withholding. Under FATCA (chapter 4), interest, royalties and dividends can still bear 30% unless a payee entity's W-8BEN-E shows a FATCA status that needs none (Publication 515; regulation 1.1473-1(a)).
Report exempt interest on Form 1042-S anyway (exemption code 05). Interest paid in shares leaves no cash to withhold from: collect the tax from the holder or gross it up (regulation 1.1441-3(e)). Going forward, see SAFEs and convertible notes.
How do we file a late Form 1042 or an amended 1042-S?
File each missing year on that year's forms. Form 1042 is required whenever a Form 1042-S is, even with no tax (Form 1042 instructions).
- Amended 1042-S: same unique form identifier, Amended box checked, amendment number ("1" first). If totals change, file an amended Form 1042 with an explanation.
- E-filing: required at 10 or more information returns of all kinds for the year (W-2s, 1099s and 1042-S together). Prior-year Forms 1042-S go through the IRS's FIRE e-filing system until it retires, expected December 31, 2026, then through its replacement, IRIS (Form 1042-S instructions). Paper Forms 1042-S go with Form 1042-T.
- Payment: pay the tax through EFTPS or IRS Direct Pay; the IRS figures penalties and interest and sends a bill.
What is the 1042 penalty for late filing, deposits and 1042-S?
Each failure has its own penalty, and interest runs until paid (Form 1042, deposit and Form 1042-S rules):
| Failure | Penalty |
|---|---|
| Form 1042 late | 5% of unpaid tax a month, up to 25% |
| Tax paid late | 0.5% of unpaid tax a month, up to 25% |
| Deposit late | 2% (1–5 days), 5% (6–15), 10% (over 15), 15% after a notice |
| Form 1042-S late, per form | $60 within 30 days, $130 by August 1, $340 after |
| Recipient copy missing, per form | Up to $340 |
| Intentional disregard, per form | Greater of $690 or 10% of the amounts |
Form 1042-S amounts are for this year's forms; older years use their own instructions. Form 1042 penalties follow unpaid tax, so a fully treaty-exempt year has none. Undeposited tax of $2,000 or more is due within 3 business days after the quarter-monthly period ends. A person responsible for the payments, such as an officer or finance head, who willfully fails to collect and pay over the tax can owe a personal penalty equal to it (section 6672).
Can reasonable cause or first-time abatement remove the penalties?
Reasonable cause can remove the filing, payment, deposit and late-form penalties, never the tax or an intentional-disregard penalty. First Time Abate may remove Form 1042 filing, payment and deposit penalties, not Form 1042-S penalties.
- Reasonable cause: not knowing the rule, or relying on someone else, generally doesn't qualify (IRS). For Form 1042-S, prompt correction plus a factor such as being a first-time filer can.
- First Time Abate: covers section 6651 and 6656 penalties on one return, with three clean prior years on the same return, or no filing requirement in them (IRM 20.1.1). Several missed years get relief for one at most.
- Unsettled: Automatic Exemption from Penalty replaces First Time Abate for listed returns due on or after January 1, 2027. Form 1042 is not listed (IRS update), and the IRS hasn't said what happens to its First Time Abate. See late filing penalties.
How many past years do we have to fix?
Every year with a payment, from the first. With no Form 1042 filed, the IRS can assess the tax at any time (section 6501(c)(3)). Filing starts the 3 years clock; an early Form 1042 counts as filed on April 15.
Do our Forms 1042-S have to match Form 5472?
No. Form 5472 shows amounts paid or accrued under the company's method and, for interest, only what section 163(j) allows (instructions). Form 1042-S shows gross amounts paid in the calendar year. Reconcile them and keep the reconciliation.
The real trap: Form 1120, Schedule K, question 19 asks whether Forms 1042 and 1042-S were required (instructions). "No" beside Form 5472 parent interest or royalties contradicts the same return. A new preparer or the parent's auditor can spot the mismatch there. For a missing Form 5472 and its $25,000 penalty, see missed foreign-owner filings.
US vs Canada: a subsidiary paying the same parent abroad
| Item | US subsidiary | Canadian subsidiary |
|---|---|---|
| Rate with no treaty | 30% | 25% Part XIII (section 212) |
| Interest to the parent | Withholding | Withholding (not arm's length) |
| Interest to an unrelated lender | Withholding unless portfolio interest or a treaty applies | None, unless participating debt interest |
| Parent's management fee, work done abroad | None (foreign-source) | Withholding unless it only reimburses a specific expense or a treaty removes it |
| Withholding missed | Tax, penalties and interest | Tax, a 10% penalty and interest |
| Year-end report | Forms 1042 and 1042-S by March 15 | NR4 by the last day of March after the payment year |
See non-resident owners of a Canadian corporation.
Example
Illustrative figures in US dollars.
$450,000 of parent loan interest
A Taiwanese server maker's Texas subsidiary paid its parent $450,000 of interest on a $10,000,000 loan in its first year, 2025, plus $300,000 for engineering work done in Taiwan under a contract that gives the subsidiary full ownership of the resulting board designs. Nothing was withheld. A new preparer spots it in October 2026 while finishing the extended 2025 Form 1120.
- Tax at 30%: $135,000 if the parent repays it; if the subsidiary absorbs it, interest grosses up to $642,857 and tax to $192,857.
- The 2025 Forms 1042 and 1042-S were due March 16, 2026: file now. Penalties and interest follow unless relief applies.
- Filed and paid by October 31, 2026, on $135,000: late filing 22.5% ($30,375: 5% a month for 5 months, less the 0.5% late-payment penalty for those months), late payment 4% ($5,400), possibly a deposit penalty of 10% ($13,500), plus interest. With no earlier Form 1042 to file, it may qualify for First Time Abate.
- The $300,000 fee needs no withholding or Form 1042-S but goes on Form 5472. Question 19 is "Yes".
- For 2026 interest, the shortfall can still come out of later 2026 payments before March 15, 2027.
A $500,000 licence fee to a UK licensor
A Delaware chip startup paid a UK company $500,000 in 2025 for interface IP used to design chips in California. Without a W-8BEN-E: 30%, $150,000 ($214,286 if grossed up). In October 2026 it collects a W-8BEN-E claiming the treaty's 0% royalty rate, with the affidavit, a FATCA status that needs no withholding, and an official document showing the licensor's UK name and address. Tax: $0. It still files 2025 Forms 1042 and 1042-S; no Form 1042 penalty without unpaid tax, but the late Form 1042-S can cost $340, plus up to $340 for the licensor's copy, unless reasonable cause applies.
$240,000 of note interest paid in shares
A Delaware GPU cloud raised $3,000,000 on 8% convertible notes from investors abroad. In March 2026, $240,000 of accrued interest converted into Series A shares; no W-8s were on file.
- Holders under 10% of the vote: if the notes are in registered form and each holder signs a W-8 with the affidavit (entities also showing a FATCA status that needs no withholding), the interest is portfolio interest: no tax, but Forms 1042-S and 1042 are due March 15, 2027.
- The holder whose $1,200,000 note, conversion right counted, gave it 12% of the vote: its $96,000 of interest owes $28,800 unless a treaty lowers it. With no cash paid, the company collects it from the holder or grosses up: $137,143 of interest, $41,143 of tax.
Different for you?
- Withholding set up right from now on: US subsidiary of a foreign company.
- Unrelated contractors abroad: paying contractors abroad.
- Rent to a landlord abroad: nonresident landlords.
- A fund's foreign investors: a new hedge fund's first year; an LLC's foreign partners: foreign partner withholding.
- A small family company's co-owner abroad: company with a foreign co-owner.
- A Canadian payee reclaiming US tax: US tax withheld on payments to Canadians.
- Other gaps found in due diligence: tax clean-up before investor due diligence.
- Several missed years, a gross-up, a late treaty claim or a reasonable-cause statement need professional judgment: cross-border tax help. For server, power and chip companies: data center tax help.
Figures on this page
| Figure | Value | Source |
|---|---|---|
| Withholding rate on US-source FDAP income paid to foreign persons Applies to the gross amount of US-source FDAP income not effectively connected with a US trade or business; a treaty may lower it. Also the rate on pay to non-resident independent contractors for services performed in the US. | 30% | IRS: Fixed, determinable, annual, or periodical (FDAP) income Checked |
| Tax as a share of the amount actually paid when a withholding agent bears 30% withholding tax Gross-up formula: amount paid ÷ (1 − 30%), then 30% of the grossed-up amount; applies when paying the tax is extra income to the payee | 42.86% | eCFR: 26 CFR 1.1441-3(f), tax liability of beneficial owner satisfied by withholding agent Checked |
| Forms 1042 and 1042-S due date for 2026 payments Form 1042-S must also be furnished to recipients by this date | March 15, 2027 Tax year 2026 | IRS: Instructions for Form 1042-S (2026) Checked |
| Voting ownership that bars the portfolio-interest exemption for corporate debt Foreign lender owns at least this share of the corporation's total combined voting power | 10% | IRS: Publication 515 Checked |
| Monthly penalty rate for late Form 1042 filing Per month or part of a month, on unpaid tax, subject to the penalty cap and reasonable-cause relief | 5% | IRS: Instructions for Form 1042 Checked |
| Maximum late filing or late payment penalty on Form 1042 Separate maximum for each penalty, based on unpaid tax | 25% | IRS: Instructions for Form 1042 Checked |
| Usual monthly penalty rate for late Form 1042 payment Per month or part of a month, on unpaid tax, subject to the penalty cap and reasonable-cause relief | 0.5% | IRS: Instructions for Form 1042 Checked |
| Form 1042 withholding tax deposit penalty, 1 to 5 days late Applied to the unpaid deposit; rates do not add together | 2% | IRS: Failure to Deposit Penalty Checked |
| Form 1042 withholding tax deposit penalty, 6 to 15 days late Applied to the unpaid deposit; rates do not add together | 5% | IRS: Failure to Deposit Penalty Checked |
| Form 1042 withholding tax deposit penalty, more than 15 days late Applied to the unpaid deposit; rates do not add together | 10% | IRS: Failure to Deposit Penalty Checked |
| Form 1042 withholding tax deposit penalty after an IRS notice More than 10 days after the first notice, or the day a notice demanding immediate payment arrives | 15% | IRS: Failure to Deposit Penalty Checked |
| Late Form 1042-S penalty when corrected within 30 days Per form for 2026 Forms 1042-S; statutory maximum and reasonable-cause rules also apply | $60 Tax year 2026 | IRS: Instructions for Form 1042-S (2026) Checked |
| Late Form 1042-S penalty when corrected after 30 days through August 1 Per form for 2026 Forms 1042-S; statutory maximum and reasonable-cause rules also apply | $130 Tax year 2026 | IRS: Instructions for Form 1042-S (2026) Checked |
| Late Form 1042-S penalty after August 1 or not filed Per form for 2026 Forms 1042-S; statutory maximum and reasonable-cause rules also apply | $340 Tax year 2026 | IRS: Instructions for Form 1042-S (2026) Checked |
| Penalty per Form 1042-S not furnished correctly to the recipient Up to this amount per form for 2026 Forms 1042-S; reduced if corrected by August 1; reasonable-cause rules apply | $340 Tax year 2026 | IRS: Instructions for Form 1042-S (2026) Checked |
| Minimum penalty per intentionally disregarded Form 1042-S The penalty is the greater of this amount or 10% of unreported items, without an annual cap | $690 Tax year 2026 | IRS: Instructions for Form 1042-S (2026) Checked |
| Percentage alternative for intentional disregard of Form 1042-S Applied to total items required to be reported if greater than the per-form dollar minimum | 10% Tax year 2026 | IRS: Instructions for Form 1042-S (2026) Checked |
| Quarter-monthly Form 1042 deposit threshold Deposit undeposited tax within three business days after the quarter-monthly period | $2,000 | IRS: Instructions for Form 1042 Checked |
| Form 1042 quarter-monthly deposit deadline After a quarter-monthly period ends when undeposited tax is at least $2,000 | 3 business days | IRS: Instructions for Form 1042, deposit requirements Checked |
| Date from which First Time Abate is no longer available First Time Abate is no longer available for eligible returns with original due dates on or after this date; Automatic Exemption from Penalty replaces it. It remains available for tax year 2024 and earlier, and for tax year 2025 returns that did not receive automatic consideration. | January 1, 2027 | IRS: Procedural update on Automatic Exemption from Penalty (IRM 20.1.1.3.3.2.5, June 17, 2026) Checked |
| General Form 1042 tax assessment period Generally measured from filing; an early-filed Form 1042 is deemed filed April 15 of the following year; no return allows assessment at any time | 3 years | IRS: Form 1042 limitations Checked |
| Deemed filing date for early-filed annual Form 1042 Following the calendar year under section 6501(b)(2); governs assessment timing, not the Form 1042 filing deadline. | April 15 | US Code: section 6501(b)(2) Checked |
| Form 5472 penalty for failure to file or keep records For tax years beginning after December 31, 2017. Per reporting corporation, per tax year. A substantially incomplete Form 5472 counts as a failure to file. IRC 6038A(d)(1); Treas. Reg. 1.6038A-4(a). | $25,000 | IRS: Instructions for Form 5472 Checked |
| Default Canadian non-resident withholding tax rate Domestic rate on specified Canadian-source payments; a tax treaty can reduce it | 25% | CRA: Non-Residents and Income Tax Checked |
| Penalty for failing to deduct required Part XIII tax Of the Part XIII tax not deducted; CRA may also assess the unpaid tax and interest | 10% | CRA: NR4 withholding, remitting and reporting Checked |
| Forms 1042 and 1042-S due date After the payment calendar year; weekends and holidays can move the deadline | March 15 | IRS: Instructions for Form 1042, Where and When To File Checked |
| NR4 filing deadline for a corporation File NR4 return and give recipients slips for the preceding calendar year; cessation can accelerate this | The last day of March after the payment year | CRA: NR4 non-resident withholding, remitting, and reporting Checked |
Primary sources
- IRS: Publication 515, Withholding of Tax on Nonresident Aliens and Foreign Entities
- IRS: Instructions for Form 1042
- IRS: Instructions for Form 1042-S
- IRS: Instructions for Form 1042-S (2025)
- IRS: Foreign source income, Form 1042-S reporting not required
- eCFR: 26 CFR 1.1441-1, Requirement for the deduction and withholding of tax
- eCFR: 26 CFR 1.1441-2, Amounts subject to withholding
- eCFR: 26 CFR 1.1441-3, Determination of amounts to be withheld
- eCFR: 26 CFR 1.1441-6, Claim of reduced withholding under an income tax treaty
- eCFR: 26 CFR 1.1473-1, Section 1473 definitions
- eCFR: 26 CFR 1.1461-2, Adjustments for overwithholding or underwithholding
- eCFR: 26 CFR 1.861-18, Classification of transactions involving digital content
- eCFR: 26 CFR 1.871-14, Rules relating to repeal of tax on interest of nonresident alien individuals and foreign corporations
- US Code: 26 USC 1461, Liability for withheld tax
- US Code: 26 USC 1463, Tax paid by recipient of income
- US Code: 26 USC 871, Tax on nonresident alien individuals
- US Code: 26 USC 318, Constructive ownership of stock
- US Code: 26 USC 6501, Limitations on assessment and collection
- US Code: 26 USC 6672, Failure to collect and pay over tax
- IRS: Form 4669, Statement of Payments Received
- IRS: Form 4670, Request for Relief of Payment of Certain Withholding Taxes
- IRS: Failure to deposit penalty
- IRS: Penalty relief for reasonable cause
- IRS: Administrative penalty relief
- IRS: IRM 20.1.1, Introduction and Penalty Relief
- IRS: IRM procedural update SBSE-20-0626-0643, Automatic Exemption from Penalty
- IRS: Instructions for Form 5472
- IRS: Instructions for Form 1120
- IRS: United States income tax treaties, A to Z
- IRS: Tax Treaty Table 1, tax rates on income other than personal service income
- U.S. Treasury: United States–United Kingdom income tax convention
- Justice Laws: Income Tax Act, section 212
About this guide
Published by Cloud Accounting under standing professional approval. This version has no separately recorded personal review. It explains general rules for the tax year shown. It is not advice for your situation.
Changes
- : First published.