The FATCA Withholding Rate: Who Is Subject to the 30% Tax?

The Foreign Account Tax Compliance Act (FATCA) is a U.S. law designed to combat tax evasion by U.S. persons using foreign accounts. A 30% withholding tax on certain U.S. source payments to foreign entities is a core enforcement mechanism. This incentivizes foreign institutions to report information about their U.S. account holders to the Internal Revenue Service (IRS).

Payments Subject to FATCA Withholding

FATCA withholding applies to “withholdable payments,” which consist of U.S. source income categorized as Fixed, Determinable, Annual, or Periodical (FDAP). This broad category captures most types of investment returns and similar income streams from within the United States.

Examples of FDAP income subject to this 30% withholding include:

• Dividends paid by U.S. corporations
• Interest earned from U.S. obligors
• Rents from property located in the U.S.
• Royalties for the use of intellectual property within the United States

FATCA also targets the gross proceeds from the sale of any property that can produce U.S. source interest or dividends. This provision prevents entities from avoiding the tax by selling an asset before it generates reportable income. For instance, the proceeds from selling a U.S. stock or bond would fall under this definition, making the gross amount of the sale subject to potential withholding.

The application of this withholding is determined by the payment’s character, not its frequency. Whether paid as a lump sum or in a series, if it qualifies as U.S. source FDAP income, it is considered a withholdable payment.

Entities Subject to the Withholding Rate

The 30% FATCA withholding primarily targets Foreign Financial Institutions (FFIs). FFIs include non-U.S. entities like banks, custodial institutions, and investment entities such as hedge funds. Withholding applies to payments made to “non-participating FFIs,” which are institutions that have not agreed to comply with FATCA’s reporting obligations.

The rules also extend to Non-Financial Foreign Entities (NFFEs), which are foreign entities that do not qualify as FFIs. An NFFE can face the 30% withholding if it fails to provide certification about its U.S. owners. A passive NFFE—one that primarily earns passive income—must either certify that it has no “substantial U.S. owners” or identify them to the U.S. withholding agent.

A “recalcitrant account holder” is an individual or entity with an account at a participating FFI that fails to provide the required information to determine their U.S. status. A compliant FFI is obligated to withhold 30% on certain payments it makes to these non-cooperative account holders.

Certain foreign entities are considered “deemed-compliant” or are otherwise exempt from withholding. These often include governmental entities, most non-profits, and some small, local financial institutions that pose a low risk of tax evasion. These entities may still need to provide documentation to a withholding agent to certify their exempt status.

Required Documentation to Avoid Withholding

To prevent the 30% withholding tax, foreign persons and entities must provide specific documentation to the U.S. payer, known as the withholding agent. This is done using the IRS Form W-8 series for foreign payees and Form W-9 for U.S. persons.

Foreign individuals use Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting (Individuals).” This form certifies an individual’s non-U.S. status and can be used to claim a reduced rate of withholding under an income tax treaty.

Foreign entities use Form W-8BEN-E, “Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities).” On this form, the entity must identify its classification under FATCA regulations, such as a participating FFI, a deemed-compliant FFI, or a specific type of NFFE. Correctly completing this form is required for an entity to establish its exemption from withholding.

U.S. persons, including citizens, resident aliens, and domestic entities, use Form W-9, “Request for Taxpayer Identification Number and Certification.” This form provides the withholding agent with the person’s Taxpayer Identification Number (TIN). Submitting a valid Form W-9 certifies that the payee is a U.S. person and not subject to FATCA withholding.

The Withholding Agent’s Responsibilities

A U.S. payer making a withholdable payment is a “withholding agent” with specific responsibilities. Failure to perform these duties can make the agent liable for the tax, plus interest and penalties. The agent’s responsibilities include:

• Determining the FATCA status of the payee before making a payment by collecting a valid Form W-8 or W-9.
• Deducting and withholding 30% from the gross amount of the payment if the payee is non-compliant or fails to provide documentation.
• Depositing the withheld tax with the IRS through the Electronic Federal Tax Payment System (EFTPS) in a timely manner.
• Filing annual reports with the IRS detailing payments and amounts withheld.

The annual reporting process involves two forms. The agent must file Form 1042, “Annual Withholding Tax Return for U.S. Source Income of Foreign Persons,” to report the total withholdable payments and tax withheld. The agent must also file Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding,” for each foreign recipient, detailing the income paid and tax withheld for that specific payee. Copies of Form 1042-S are sent to both the IRS and the payee.

Recovering Improperly Withheld Funds

Foreign persons and entities can recover funds that were improperly withheld under FATCA. The regulations provide two primary pathways for recovery, depending on the timing of the claim.

The most direct method is the collective refund procedure. If the withholding agent discovers an overwithholding error before filing the annual Form 1042, it can often resolve the issue directly. The agent may repay the improperly withheld amount to the payee and then reduce a subsequent tax deposit.

If the agent has already filed its Form 1042, or if the agent is unable to process the refund, the foreign payee must seek recourse from the IRS. The payee can file a U.S. tax return to claim a refund of the overwithheld amount. A foreign individual would file Form 1040-NR, while a foreign corporation would use Form 1120-F.

The Form 1042-S provided by the withholding agent is a necessary document for this process, as it substantiates the income and tax withheld. The IRS will only issue a refund for amounts the withholding agent has deposited with the U.S. Treasury. If an agent withholds tax but fails to remit it, the foreign payee cannot recover the funds from the government.