The Internal Revenue Service (IRS) recently began denying refunds of withholding tax credits claimed on Form 1040NR, U.S. Nonresident Alien Income Tax Return, as substantiated on Forms 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding. This development appears to be in connection with the April 28, 2015 issuance of Notice 2015-10 (Notice) by the US Department of the Treasury (Treasury) and the IRS. The Notice states that Treasury and the IRS intend to promulgate regulations and establish Internal Revenue Manual (IRM) procedures to limit claims for refunds or credit from withholding taxes reported on Form 1042-S to amounts verified by the IRS as actually deposited.
IRM Section 21.8.1 was updated on January 19, 2016 to describe the IRS procedures to implement the Notice’s limited refund and credit process. The government indicated in the Notice that the planned regulations and presumably the IRM procedures would apply to refund or credit amounts withheld in calendar year 2015. These procedures appear to have been implemented on amounts withheld in years prior to 2015. Recent IRS correspondence indicates that individual refunds or credits claimed on 2014 Forms 1040NR for taxes withheld and reported on 2014 Forms 1042-S are being denied. The correspondence also indicates either that the IRS was unable to verify that the reported amounts were deposited or that the individual’s Form 1042-S information did not match the information reported by their withholding agent.
This development comes at a time when observers have noted increased enforcement activity by the IRS in the US information reporting arena despite budget constraints. The IRS has now followed through to increase its scrutiny of, and tighten its standards for, documentation required for refund and credit claims for over withholding on payments to non-US recipients. Together, these developments have made it more difficult for withholding agents and non-US persons to claim refunds of withheld tax. It is essential that individual taxpayers proactively work with withholding agents to address the cause of the IRS denial of a refund or credit claims.