As AP and Tax professionals hopefully know - the IRS has been on an enforcement push in regards to auditing 1042/1042-S reportable payments made to Non-U.S. payees. However, an increasing number of 1042/1042-S related audits are being expanded into the 1099 world. 

This is because an IRS audit revolving around Form 1042 (including withholding procedures) can result in an adjustment to both Form 1042 and Form 945 (with the latter the form used for reporting backup withholding in a 1099 context). Therefore, when auditing Form 1042, IRS examiner's are being instructed to determine the statute of limitations on the audit years for both Form 1042 and Form 945.

Examiners are being directed to comb the records of those organization's under audit for evidence of potential audit expansion into the 1099 realm. This is done via a number of techniques. One of the most common is for the auditor to look at your organization's written accounts payable, payroll, and tax policies and procedures via reviewing:

• Summaries of withholding tax systems
• System flow charts covering payments made to account holders
• Internal control, audit reports or other information which relate to the withholding tax function; and
• Manuals related to functions that may have withholding tax implications, including: payment system design; account opening procedures; validation procedures for Forms W-8; procedures for determining or classifying undocumented accounts; and application of IRS presumption rules regarding 1099 versus 1042-S reportable payments.

In addition, the IRS is also directing it's auditors to examine training manuals and activities used for departments (such as accounts payable) that control the following functions: NRA withholding tax determinations or implementation; Opening new accounts for both U.S. Persons (using Form W-9) and Non-U.S. Persons (using Form W-8); Preparing Forms 1042 & 1042-S.

From there, the auditor's evaluation of the above written procedures (or lack thereof) are used to provide the IRS with an indicator of the overall reliability of your organization's withholding tax functions. Why is this important? Because this is a key component in determining if the IRS is satisfied - or whether additional audit procedures, such as the review of account files statements and withholding certificates, should be conducted.

If you need help please don't hesitate to explore our tax advisory services, tax guides, or our latest webinars - all designed to offer you flexible options for training or supporting your accounts payable and tax teams in handling issues such as these!