What Is Form 1042-S Exemption Code 04?
Learn what Form 1042-S Code 04 signifies and the process for using a tax treaty, from providing correct documentation to reporting the income to the IRS.
Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding,” is a tax document used by entities like businesses and universities. These organizations, known as withholding agents, use the form to report U.S. source income paid to foreign persons. The form contains various codes that specify why certain income might be taxed at a reduced rate or not at all, including Exemption Code 04.
Defining Exemption Code 04
Exemption Code 04, found in Box 3a of Form 1042-S, signifies that the income is “Exempt under a tax treaty.” This code is used when the tax rate in Box 3b is “00.00,” indicating no tax was withheld. A tax treaty is a formal agreement between the United States and another country designed to prevent the same income from being taxed by both jurisdictions.
The purpose of these treaties is to clarify tax jurisdiction and encourage international commerce. Common examples of income that may qualify for treaty benefits and be reported under Code 04 include scholarships, fellowship grants, and compensation for independent personal services. For instance, income code 16 is used for scholarships or fellowship grants, while income code 17 denotes payments for independent personal services.
Requirements for Claiming the Exemption
A withholding agent cannot apply a tax treaty exemption without first receiving specific documentation from the foreign person. The primary requirement is for the recipient to provide the payer with a valid Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding and Reporting.” This form establishes the individual’s foreign status and is the instrument used to claim treaty benefits.
To properly claim the exemption, the recipient must complete Part II of Form W-8BEN, titled “Claim of Tax Treaty Benefits.” In this section, the individual must certify their country of tax residence and identify the specific article of the tax treaty that allows for the exemption. A U.S. Taxpayer Identification Number (TIN) is also generally required to claim treaty benefits, as the payer may be required to withhold tax at the default 30% rate if a TIN is not provided.
Recipient Reporting Obligations
Receiving a Form 1042-S with Exemption Code 04 does not end the recipient’s obligations to the IRS. Even though the income was exempt from withholding, it generally must still be reported on a U.S. tax return. Most foreign persons who receive U.S. source income are required to file a Form 1040-NR, “U.S. Nonresident Alien Income Tax Return,” to report these earnings.
When filing the tax return, the recipient must report the income amount shown in Box 2 of the Form 1042-S. It is standard procedure to attach a copy of the Form 1042-S to the Form 1040-NR as documentation supporting the treaty claim. The recipient will typically receive three copies of the Form 1042-S from the payer: Copy B for personal records, Copy C for the federal return, and Copy D for any state filing requirements.