By David Duner, CPA and Del Facundo, CPA
November 30, 2016

This article is meant to describe the IRS filing and tax withholding requirements regarding the payment of interest income to a nonresident alien by a loan servicing agent.

There are several forms and withholding tax considerations to be aware of.
A mortgage broker/loan servicing agent first needs to determine if the investor is a nonresident alien or a resident alien.
A resident alien is an individual that has been physically present in the United States for no less than 31 days in the current year, and has been physically present in the United States for no less than 183 days over a three-year period, including the current year, and the two preceding years. Therefore, he or she would pass the substantial presence test and would be classified as a resident alien. A resident alien can also be an individual that has a Green Card permit that allows the individual to legally live and work in the United States on a permanent basis.

A resident alien is generally subject to tax in the same manner as a U.S. citizen. A resident alien who is not a green card holder must have a taxpayer identification number from the Internal Revenue Service. A resident alien who is a green card holder must have a social security number. A loan servicing agent will treat a resident alien the same as a U.S. citizen and simply issue an IRS form 1099INT to the individual indicating the amount of interest income received for the taxable year and no tax withholding requirements are necessary.

A nonresident alien is an individual who is a non-U.S. citizen, and does not pass the green card test or the substantial presence test for a calendar year.
A nonresident alien is subject to U.S. income tax only on U.S. source income.

The loan servicing agent must first obtain IRS form W-9, Request for Taxpayer Identification Number and Certification, from the individual. This form will provide the loan servicing agent with either the social security number or the taxpayer identification number. The individual needs to use IRS Form W-7 (Application for IRS Individual Taxpayer ID number) to obtain these identification numbers.

To a nonresident alien, interest income is considered by the IRS to be Fixed, or Determinable Annual, or Periodical Income (FDAP), and is subject to the flat 30% (or a lower treaty rate) withholding tax. The withholding tax rate is applied to the gross amount of the interest income, meaning that no deductions are allowed against such income (i.e. loan servicing fees).

It is the responsibility of the withholding agent (loan servicing agent) to withhold tax on each interest payment made to a nonresident alien.
A possible lower tax withholding rate on interest income can be used if the United States has a tax treaty with the foreign country. For example, the tax withholding rate on interest income for citizens of the Peoples Republic of China is 10%. The withholding rate for citizens of Israel is 17.5%, and for citizens of India it is 15%.

The loan servicing agent must obtain from the nonresident alien IRS Form W-8BEN, Certificate of Foreign Status of Beneficial Owner for US Tax Withholding and Reporting (Individuals). This form will provide the tax payer identification number of the nonresident alien to the loan servicing agent.  Line 9 of the form certifies the country in which the nonresident alien lives and that if an income tax treaty exists between that country and the U.S.  Line 10 of the form specifies the treaty tax withholding rate at which the gross interest income shall be subject to.  This form must be retained in your records and does not need to be submitted to the IRS.
The burden is on the foreign lender to provide the necessary information to the loan servicing agent on the form W-8BEN.  The loan servicing agent can verify the tax withholding rate for a particular country by looking it up on “Table 1 – Withholding Tax Rates on Income Other Than Personal Service Income Under Chapter 3, Internal Revenue Code, and Income Tax Treaties” by going to the following URL on the IRS website http://www.irs.gov/Individuals/International-Taxpayers/Tax-Treaty-Tables.

withheld from the payment and the year to date amount of tax withheld.

How to Remit the Withholding Tax to the IRS:

The total amount of the tax withheld determines how frequent the tax needs to be paid to the IRS. All withheld taxes must be deposited by electronic fund transfer (EFT) using the Electronic Federal Tax Payment System (EFTPS).
The following rules apply:

  1. If at the end of a calendar year the total amount of undeposited taxes is less than $200, you must deposit the entire amount by March 15 of the following calendar year.
  2. If at the end of any month the total amount of undeposited taxes is $200 or more but less than $2,000 you must deposit the taxes within 15 days after the end of the month
  3. If at the end of any quarter/monthly period the total amount of undeposited taxes is $2,000 or more, you must deposit the taxes within 3 business days after the end of the period.

IRS Annual Tax Form Reporting Requirements:
IRS form 1042-S, Foreign Person’s U.S. source Income Subject to Withholding –
IRS form 1042-S must be electronically filed with the IRS and provided to the lender/payee by March 15th of the following year. This form reports the amounts paid and the taxes withheld. It provides the basic information about the payee and the withholding agent (tax id numbers, addresses, etc.). Note that even if the recipient is exempt from withholding tax, or the treaty tax rate is zero, you still must file IRS Form 1042-S.

IRS form 1042, Annual withholding Tax Return for U.S. Source Income of Foreign Persons –

IRS form 1042 must be electronically filed with the IRS by March 15th of the following year. This form reports the monthly federal tax liability of the withholding agent during the year. It also reconciles the total tax deposits made to the total liability for the year.

General Responsibility of Nonresident Alien

If a nonresident alien individual has US-sourced income but is not engaged in a trade or business in the U.S. during the tax year, and his or her tax liability is fully satisfied by the withholding of tax at the source, the taxpayer is not required to file a tax return for the year. However, if a nonresident alien wants to obtain a refund of over-withheld taxes, to satisfy an additional tax liability, or to claim income exempt or partly exempt by treaty, he or she must file a tax return (IRS form 1040NR) even if, because of low taxable income, a return is not required.

This article is meant for information purposes only. The specific rules related to the above subject are more in depth. Please consult your tax advisor for additional information and specific requirements.
David Duner, CPA is the managing partner and founder of David Allen Duner, Certified Public Accountants, Irvine, CA.  Del Facundo, CPA is a tax manager.  Our firm has been providing audit and tax services to the mortgage industry for over 25 years.  We can be reached at (949) 263-0030 or at David@DunerCPA.com or Del@DunerCPA.com