The Difference Between IRS Forms 1099 and 1042-S

DO YOU HAVE FOREIGN OWNERS/INVESTORS?

As a property manager, you are very much aware that by law, you must issue a 1099 form reporting gross rents to your property owners by 1/31 of every year. 

However, there seems to be a great deal of confusion out there when it comes to property managers with owners that are citizens of foreign countries.  You see, foreign investors do not get issued a 1099.  What do they receive?  They get issued a 1042-S.

WHAT IS THE DIFFERENCE BETWEEN FORMS 1099 AND 1042-S?

A 1099 form is used to report miscellaneous income, such as gross rent, for US residents and businesses only, whereas a 1042-S (Foreign Person’s U.S. Source Income Subject to withholding) is used to report income paid to a non-resident regardless of whether the payment is taxable.  Unlike form 1099, form 1042-S is not due to be issued until March15th of every year.

I see way too many property managers issuing a 1099 form to a foreign citizen.  This will lead to serious audit problems in the future as the IRS is cracking down on property managers filing the incorrect form.

The function of form 1042-S is to let the IRS know that a foreign person has earned income in the USA.   For the purposes of the IRS, a foreign person includes a non-resident alien individual, a foreign corporation, a foreign partnership, a foreign trust, a foreign estate and any other person that is not a US person.  When a foreign person or entity has earned income in the USA they must file an annual non- resident tax return. The IRS uses the     1042-S as a means to monitor tax filing compliance on the part of a foreign person or entity.

MAKE SURE YOU ALSO HAVE FORM W-8ECI ON FILE FOR EVERY FOREIGN CLIENT

As a property manager, you would report the annual gross rents on the form and also report any federal taxes withheld.  This is an important note: If you do not have a form W-8ECI (Certificate of Foreign Person’s Claim that income is Effectively Connected With the Conduct of a Trade or Business in the United States) on file for your foreign client, you should have withheld and submitted to the IRS 30% of the gross rents of your client.  The IRS also uses form 1042-S to monitor your compliance with this.  Failure to be compliant with this law may result in the IRS going after your company for the taxes owed by your client.  Therefore the message is clear: Make sure that you have this form on file for every foreign client you have!  You also want to obtain an updated W-8ECI every 3 years but I would suggest making it part of your annual checklist when renewing the management contract.

FORM 1042-T

After you file your 1042-S with the IRS, you will also have to file an annual form 1042T (Annual Summary and Transmittal of Forms 1042-S)  which is a tax reporting form that reconciles all of the 1042-S forms and tax withholding deposits to all of your form 1042-S paperwork.  This form is also due to be issued by March 15th of every year.

GROSS RENTS BOX ON FORMS 1099 AND 1042-S

I have noticed that there seems to be some confusion as to what constitutes reportable annual rental income that should be listed under the Gross Rents boxes on forms1099 and 1042-S.

The second part of this article will help all property managers have a clear understanding of the tax rules that apply to this box.

The following are common types of income:

ADVANCE RENT

Advance rent is any amount you receive before the period that it covers.  Include advance rent in rental income in the year received regardless of the period covered or the method of accounting you use.

Example

  • On May 15th, 2011 you signed a 2 year lease to rent property.
  • The tenant decides to prepay the entire lease.
  • You receive $10,000 for the first year’s rent and $10,000 for the rent on the second year.
  • The whole $20,000 must be reported on form 1099 in 2011.

CANCELING A LEASE

If tenant pays to cancel a lease, this payment is reported as rental income.  Include the amount on form 1099 in the year that it is received.

EXPENSES PAID BY THE TENANT

If tenant pays any of your rental expenses, the amount paid should be included in rental income and you would also deduct the expense.

Example

  • If the furnace in the rental property stops working and the tenant pays for the necessary repairs and deducts the amount from the rent payment.  The amount paid by the tenant would be included in rental income and the repair would be deducted as an expense.

PROPERTY OR SERVICES

If you receive property or services as rent instead of money, include the fair market value of the property or services as rental income in the year received.

Example

  • Your tenant is a house painter.  He offers to paint your rental property instead of paying two months rent.  You include in rental income the amount he would have paid for rent and deduct the same amount as an expense.

SECURITY DEPOSITS

This is the area where I see the most confusion.  Do not include a security deposit in rental income when you receive it if you plan to return the deposit to the tenant at the end of the lease.  If you keep part or all of a security deposit during the year because your tenant does not live up to the terms of the lease, include the amount you keep in rental income for the year.

If an amount called a security deposit is to be used as final payment of rent, it is advance rent and should be included in rental income in the year received.

I hope that this article gives clear direction on the IRS tax guidelines for what is reportable rental income, as well as helping all of you with foreign clients to establish a system within your office to remain compliant with the IRS and protect yourselves from costly audits!

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Guest article written by Richard Hart with Hart & Associates:

Richard Hart EA, CAA
President
Hart & Associates
Tax Consulting and Preparation Services
702-985-7148
www.hartassociate.com