As Tax Season Looms, Form 1042 Makes the Leap to Digital Filing

Tax season is here, and the march towards digitization of records and electronic filing continues.

Wendy Walker, solutions principal at Sovos, told PYMNTS that new e-File requirements — in this case, for Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons — underscore challenges firms face as they meet the government’s quest to modernize tax reporting.

Form 1042, she said, exists as an annual reconciliation return to the IRS, reporting details from 1042-S forms that were issued by the same business. 

The 1042-S documents themselves are mandatory when a business pays income from U.S. sources to foreign individuals or entities. 

On a practical level, the payee takes the information from the Form 1042-S, reports that data on their own income tax return to the IRS, and pays anything owed (or receives a refund for any overpayments).

“This is just like 1099 or W2 reporting,” Walker said. 

What’s Changing

But changes are on the horizon — and may present some stumbling blocks for unprepared firms. The IRS has stipulated that all financial institutions and insurance firms file their 1042 forms electronically, beginning with their 2023 returns (the current tax season). Smaller firms, such as partnerships, are also required to file the Form 1042 electronically if they cross a 10-return threshold.

In the past, Walker said, businesses could only file the Form 1042 with the IRS on paper. But there would often be mismatches because they received details from individual 1042-S submissions electronically — which meant the IRS was processing returns without having the most complete information at hand. That meant trying to claw back refunds, at times, from non-U.S. payees. 

For the companies that don’t comply with the e-File mandate or submit documentation that does not reconcile accurately to the individual 1042-S forms they filed, the impact can be significant. 

“It’s risky to disregard the requirements,” she said. If firms are not in compliance, audits and penalty notices loom. 

The complexities become apparent when firms seek to move their Form 1042 reporting to the modernized e-File platform. The 1042 is filed with different systems than would be used for other forms, like 1099s or 1042-S forms.

“The credentials that you need to access the IRS Modernized e-File platform are not the same” as might be seen elsewhere, she said. Filing formats are different, too. 

In addition to establishing identities through the ID.me platform, only specific parties such as a licensed attorney or CPA can be designated as responsible officials for the company transmitting the data. In some cases, an individual may need to demonstrate that they are a bona fide officer of a firm. And businesses, she added, are required to “test” with the IRS annually in order to e-File in the first place.

Looking ahead, she said that Form 941 (for employment taxes) is likely to see an electronic filing mandate, as past years have seen significant processing backlogs related to those documents. In the meantime, for those firms banking on a delay of the Form 1042 requirements … well, don’t bank on it, Walker warned. 

“The IRS is working very hard to eliminate paper,” she said, adding that “Modernized e-File is not a new system.” 

Firms such as Sovos, she said, have already been using the system to e-File all manner of income tax and withholding returns, and now the 1042 is simply another document to add to the roster. 

Companies, she said, “need to consider whether you want to be a large volume software filer, filing directly with the IRS, or if you want to rely on a tax service provider who is already filing your corporate income tax return, and other returns that have already been mandated.”

As she told PYMNTS, choosing to work with providers may be the easier route, taking advantage of a helping hand, “as providers continue to grow their automated processes, as the IRS will be doing the same over the next few years.”