What Are the IRS Chapter 4 Compliance Requirements?

Chapter 4 of the Internal Revenue Code contains the authority for the Foreign Account Tax Compliance Act (FATCA). This legislation addresses tax evasion by U.S. persons using offshore accounts to conceal income and assets. FATCA enhances transparency by requiring foreign financial institutions and certain non-financial foreign entities to report information about their U.S. account holders to the Internal Revenue Service (IRS). This structure enlists foreign institutions into cooperating with U.S. tax authorities. Foreign entities that fail to comply with identification and reporting requirements can face a significant withholding tax on certain U.S. source payments they receive.

Entities Subject to Chapter 4

A central figure in the FATCA framework is the U.S. Withholding Agent (WA). A WA is any U.S. person or foreign person that has control, receipt, custody, disposal, or payment of a “withholdable payment.” This broad definition includes U.S. financial institutions like banks and brokerage firms, as well as corporations making payments such as interest or dividends to foreign entities. The responsibility of a WA is to implement Chapter 4 requirements by collecting documentation and, when necessary, withholding tax and reporting to the IRS.

Foreign Financial Institutions (FFIs) are a primary focus of Chapter 4. An FFI is broadly defined and includes entities such as depository institutions (banks), custodial institutions, investment entities like hedge funds or private equity funds, and certain insurance companies that issue cash value or annuity contracts. A Participating FFI (PFFI) is an institution that agrees with the IRS to comply with FATCA obligations, which includes identifying and reporting on its U.S. accounts.

To formalize this agreement, a PFFI registers on the IRS FATCA portal to obtain a Global Intermediary Identification Number (GIIN), which serves as proof of its compliant status. Other classifications include Registered Deemed-Compliant FFIs, which have simplified requirements. In contrast, Nonparticipating FFIs are those that have not agreed to comply and face a 30% withholding tax on certain U.S. source payments.

The other major category is the Non-Financial Foreign Entity (NFFE), which is any foreign entity not defined as an FFI. NFFEs are divided into Active and Passive subcategories. An Active NFFE is an operating business that generates most of its income from selling goods or services, leading to lower reporting requirements.

A Passive NFFE is an entity where 50% or more of its gross income is passive, or 50% or more of its assets produce passive income. Withholding agents making payments to a Passive NFFE must obtain information about any “substantial U.S. owners” of that entity. A substantial U.S. owner is a U.S. person who directly or indirectly owns more than 10 percent of the entity.

Payee Documentation and Due Diligence

Chapter 4 compliance relies on a withholding agent’s due diligence to determine the status of any foreign payee. This process involves collecting and validating specific tax forms to identify whether the payee is a U.S. person, a compliant foreign entity, or a non-compliant entity subject to withholding.

The primary forms are the IRS Form W-9 and the Form W-8 series. A Form W-9, Request for Taxpayer Identification Number and Certification, is used to identify and document U.S. persons. By providing a valid Form W-9, the payee certifies its U.S. status, and the payment falls outside the scope of Chapter 4 withholding.

For foreign payees, the Form W-8 series establishes their identity and foreign status. Form W-8BEN is used by foreign individuals to claim foreign status and any applicable tax treaty benefits. For foreign entities, Form W-8BEN-E, Certificate of Status of Beneficial Owner for United States Tax Withholding and Reporting (Entities), is the document used to determine an entity’s Chapter 4 status. Other forms in the series, like Form W-8IMY for intermediaries and Form W-8ECI for income connected to a U.S. business, serve more specialized purposes.

Form W-8BEN-E requires the foreign entity to self-certify its classification from a list of options, such as Participating FFI, Active NFFE, or Passive NFFE. For example, an entity certifying as a Participating FFI must provide its GIIN. A Passive NFFE must use the form to either certify that it has no substantial U.S. owners or provide the name, address, and Taxpayer Identification Number (TIN) of each one.

Withholding agents are responsible for obtaining these forms from payees before making payments. The agent must review the form for completeness and reasonableness, checking that all required fields are filled and the information is consistent. An incomplete or unreliable form is invalid and cannot be used to reduce the rate of withholding.

Withholding Requirements

After performing due diligence, a withholding agent determines if withholding is necessary. The obligation to withhold under Chapter 4 is triggered when a “withholdable payment” is made to certain non-compliant foreign entities. A withholdable payment is defined as a payment of U.S. source fixed, determinable, annual, or periodical (FDAP) income, such as interest, dividends, rents, royalties, and salaries.

The 30% FATCA tax is required in specific scenarios. The primary trigger is making a withholdable payment to a Nonparticipating FFI, which is any FFI that has not agreed to comply with FATCA regulations. Without a valid Form W-8BEN-E certifying a compliant status, the withholding agent must presume the FFI is nonparticipating and apply the tax.

A second trigger involves payments to Passive NFFEs. If a withholding agent makes a withholdable payment to a Passive NFFE that fails to provide the required documentation about its substantial U.S. owners, the 30% tax must be withheld. This acts as a penalty for the lack of transparency.

After withholding the tax, the agent must deposit the funds with the IRS. These deposits are made using the Electronic Federal Tax Payment System (EFTPS). The frequency of deposits depends on the total amount of tax withheld.

Annual Reporting Obligations

Withholding agents have annual reporting obligations to the IRS that reconcile payments made and taxes withheld. This reporting is primarily accomplished through the Form 1042 series.

Agents must file a Form 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, for each foreign payee that received a withholdable payment. This form details the type and amount of income paid, the recipient’s Chapter 4 status, and any tax withheld. A separate Form 1042-S is prepared for each recipient.

To summarize the information from all individual Forms 1042-S, agents file a single Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons. This form reconciles the agent’s total withholding liability for the year. It aggregates the total income paid and tax withheld and compares it to the tax deposits made, allowing the IRS to match the reported liability with the actual funds received.

In addition to this reporting, FFIs and other entities have their own duties. Form 8966, FATCA Report, is used by FFIs to report details of their U.S. accounts and by withholding agents to report the substantial U.S. owners of a Passive NFFE. This form provides the IRS with direct information about U.S. taxpayers’ foreign assets.

The filing deadline for Forms 1042 and 1042-S is March 15 of the year following the calendar year of the payments. Electronic filing is mandatory for most withholding agents, who must submit the forms through designated IRS electronic systems.