Last week, Kimberly Schoenbacher, the Acting Director of Field Operations for the LB&I Foreign Payments Practice (“FPP”), sent a message to taxpayers who may be noncompliant with Chapter 3 and FATCA withholding and reporting: the IRS is actively honing in on Form 1042 nonfilers, Form 1042 failures, and Forms 1042 and 1042-S that do not reconcile. Schoenbacher remarked at the International Tax Withholding and Information Reporting Conference in New York that the IRS has sent letters to thousands of taxpayers across the country regarding compliance failures related to Forms 1042 (Annual Withholding Tax Return for U.S. Source Income of Foreign Persons) and 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding). The letters were issued under the Form 1042/1042-S compliance campaign announced by LB&I in 2018. The campaign seeks to address withholding, deposit, and reporting noncompliance on the part of withholding agents making payments of U.S.-source income to foreign persons.

Earlier this year, the FPP launched a correction program that provides withholding agents with the opportunity to address Form 1042 and 1042-S failures and request penalty relief (earlier coverage). However, Schoenbacher warned that time is running out for many withholding agents (and has already run out for some) slated to receive letters denoting Form 1042/1042-S compliance failures. Importantly, withholding agents receiving these compliance letters or pulled for audit are barred from participating in the correction program. Practically, this means that withholding agents will have a tougher time seeking penalty relief than those applying to the program. She pledged that more letters will soon be issued and those failing to respond will be referred for audit.

More than a decade ago, Barry Shott, the former Deputy Commissioner (International) of LMSB (the predecessor to LB&I) issued numerous warnings to taxpayers that Chapter 3 audits were coming. These were the days prior to the passage of FATCA, when the IRS only needed to focus on Chapter 3 noncompliance such as failing to properly report and withhold on intercompany payments of U.S.-source income to foreign affiliates when the same payments were disclosed on Schedule M of Forms 5471. Even armed with such roadmaps, there were mixed reviews regarding the effectiveness of the Service’s predicted enforcement. Although withholding compliance has become more complex with the adoption of FATCA, the IRS has greater enforcement expertise regarding Form 1042 and 1042-S compliance than it used to, and FPP seems to be using its resources more effectively. Taxpayers should confirm that their Chapter 3 and Chapter 4 compliance procedures are working as intended given the warnings of pending enforcement, and if the procedures are not working, consider taking advantage of the correction program.