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Jennifer Zamarin
November 01, 2010 Article 7 min read

The Internal Revenue Service is cracking down hard on businesses that make payments to foreign persons. The IRS requires US taxpayers to both withhold the proper amounts (often 30 percent) and retain Form W-8. Requesting the proper Form W-8 before you make any payments will help you avoid potential penalties for withholding noncompliance.

Below is a general discussion on Form W-8 and related withholding. Please consult your tax advisor regarding your individual circumstances.

In General

If you pay income to foreign persons (including non-resident aliens, foreign corporations, foreign partnerships, foreign trusts, foreign estates, foreign governments, and international organizations), you may become a withholding agent, responsible for withholding on payments, and filing and retaining pertinent tax documentation. You are a withholding agent if you are a US or foreign person with control, receipt, custody, disposal, or payments of any item of income of a foreign person subject to withholding. Generally, a foreign person is subject to US tax on its US income. Most types of US source income received by a foreign person are subject to 30 percent withholding requirements unless they are exempt or reduced by tax treaties.

Tax treaties between the US and other countries may provide for a reduced rate or, in some circumstances, an exemption from paying tax on the US income. As a withholding agent, you can apply the reduced rate or exemption if you can reliably associate the payment with documentation establishing that the income recipient is a US person or a foreign person entitled to the benefit. This documentation can come in a number of forms and is generally provided on Form 8233 for personal service income and a version of Form W-8 for other income. In the absence of proper documentation, you are liable for the tax that must be withheld. As a withholding agent, you may rely on a payee’s claim of a treaty benefit if at the time of payment you do not have reason to believe a claim to be false.

Forms W-8

  • W-8BEN, Certificate of Foreign Status of Beneficial Owner for US Tax Withholding
    • Most foreign persons, corporations, or other companies provide Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for US Tax Withholding. This form certifies that the payee is, and should be treated as, a foreign payee for tax withholding purposes. If applicable, this form is used by a payee to claim a reduced withholding rate or a withholding exemption. Form W-8BEN can also be provided by a foreign person to claim an exemption from Form 1099 reporting and backup withholding.
    • Generally, you should request a Form W-8BEN from any foreign person or organization to which you are making a payment that would constitute gross income to them, regardless of whether they are claiming treaty benefits. Additionally, if you are a partnership, request Form W-8BEN from any foreign partner that is allocated US income unless that partner is a foreign partnership or foreign grantor trust.
  • W-8ECI, Certificate of Foreign Person’s Claim That Income Is Effectively Connected With the Conduct of a Trade or Business in the US
    • Form W-8ECI, Certificate of Foreign Person’s Claim.  That Income is Effectively Connected With the Conduct of a Trade or Business in the US, certifies that a foreign payee has a trade or business in the US effectively connected with the income received. The form also establishes the payee’s foreign status and claim to be the owner of the income.
    • In general, effectively connected income (ECI) for which a valid Form W-8ECI is provided is not subject to withholding unless the form is provided by a partner to a partnership. If you receive Form W-8ECI without a US TIN, you may not be able to treat the income as effectively connected with a business in the US and must withhold.
  • W-8EXP, Certificate of Foreign Government or Other Foreign Organization for US Tax Withholding
    • Form W-8EXP, Certificate of Foreign Government or Other Foreign Organization for US Tax Withholding, is used by a foreign tax-exempt organization or a foreign private foundation to establish its foreign status and its claim to be the owner of the income for which the form is provided, and if applicable, to claim a reduced withholding rate or a withholding exemption.
  • W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain US Branches for US Tax Withholding
    • Payments made to a foreign flow-through entity are treated as being made to the owners. The flow-through entity must provide Form W-8IMY, Certificate of Foreign Intermediary, Foreign Flow-Through Entity, or Certain US Branches for US Tax Withholding, to the payer to establish its withholding status. In order for you to reliably associate a payment to the entity with the payees, Form W-8IMY must be accompanied by additional information about the owners, provided on Form W-8 or W-9, depending on the status of the owners. Additional information reported on the form depends on the type of flow-through entity and the withholding responsibilities it assumes. 

Documentation for Foreign Partners

If the partner is a: Request Form:
Nonresident alien W-8BEN
Foreign corporation W-8BEN
Foreign partnership W-8IMY
Foreign grantor trust W-8IMY
Foreign estate W-8EXP

Expiration Dates

Generally, Forms W-8BEN, W-8ECI, W-8EXP, or a substitute form expire at the end of the third calendar year following the year in which it is signed or created. For example, a Form W-8BEN signed on January 10, 2008 remains valid through December 31, 2011. Form W-8IMY usually remains valid for an indefinite period. However, when the information reported on any of these forms becomes incorrect due to a change in circumstances, the form becomes invalid. On the date received, you may date the Form W-8 if the provider failed to do so.

Penalties

As a withholding agent, you are personally liable for any tax required to be withheld. If you fail to withhold and the foreign payee fails to satisfy its US tax liability, the IRS can come after you to pay the tax, plus penalties and interests [Reg. 1.1461-1(a)]. 

The following penalties/assessments may apply:

  • Failure to withhold the required tax: Liability for 100 percent of the withholding amount if the IRS cannot collect it from the payee
  • Failure to make deposit of taxes
    • In general
      • 2 percent if the failure is not more than 5 days
      • 5 percent if the failure is more than 5 days but not more than 15 days
      • 10 percent if the failure is more than 15 days
    • Special rule 15 percent in any case where the tax is not deposited on or before the earlier of
      • the day 10 days after the date of the first delinquency notice to the taxpayer, or
      • the day on which notice and demand for immediate payment is given
  • Failure to collect and pay over tax (IRC Sec. 6672)

Any person required to collect, truthfully account for, and pay over any tax imposed by this title who willfully fails to collect such tax, or truthfully account for and pay over such tax, or willfully attempts in any manner to evade or defeat any such tax or the payment thereof, shall, in addition to other penalties provided by law, be liable to a penalty equal to the total amount of the tax evaded, or not collected, or not accounted for and paid over.

  • Willful failure to collect or pay over tax (IRC Sec. 7202)

Any person required under this title to collect, account for, and pay over any tax imposed by this title who willfully fails to collect or truthfully account for and pay over such tax shall, in addition to other penalties provided by law, be guilty of a felony and, upon conviction thereof, shall be fined not more than $10,000, or imprisoned not more than 5 years, or both, together with the costs of prosecution.

Misstatements on W-8s

You are not responsible for misstatements on a Form W-8 or other documentation provided to you claiming a reduced rate under a treaty. If, however, you do know or have reason to believe that a payee is not eligible for a reduced rate, you must not apply the treaty rate claimed.

What should I do now?

If you make payments to any foreign person, you should do the following before making a payment:

  1. Determine the type of entity you are making the payments to (individual, corporation, partnership, trusts, estates, government, international organization, etc.)
  2. Determine the type of payments you are making (interest, dividends, service fees, ECI, etc.)
  3. Request the appropriate Form W-8 based on 1 and 2 above
  4. Review the Form W-8 to make sure it is complete before making your payment, and withhold accordingly
  5. Periodically review W-8s in your files and request new W-8s if they are set to expire at the end of the year, or if a change in circumstances makes a form incorrect. You need to have a valid W-8 on hand before you make your payments.

This written advice is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.