US Withholding on Payments to Foreign Persons: Chapter 3, Chapter 4, 1042 and 1042-S

A US company that pays a dividend to a parent in Toronto, interest to a lender in Mumbai or a royalty to a software licensor in Hyderabad may have to hold back tax before the money leaves the country. If you are the payer, you are the withholding agent, and the IRS can collect the tax from you if you did not collect it. This guide to US withholding on payments to foreign persons covers the rules, the forms and the treaty rates for Canada and India, for payments in 2026 and reports filed in 2027.

Who handles US withholding on payments to foreign persons

A withholding agent is any US or foreign person with control, receipt, custody, disposal or payment of an amount subject to withholding. It can be an individual, a corporation, a partnership or a trust. You are personally liable for tax you should have withheld, and the liability is independent of the foreign payee's own liability. The tax is collected only once, but you remain liable for interest and penalties if you failed to withhold.

Chapter 3 and Chapter 4: what is the difference?

Under chapter 4, a payment to a foreign financial institution is subject to 30% withholding unless the payee is documented as a participating, deemed-compliant or exempt institution. A payment to a non-financial foreign entity is subject to 30% unless the entity identifies its substantial US owners or certifies it has none. A single Form W-8BEN-E captures both the treaty claim and the chapter 4 status.

Which payments are covered?

• Covered: US-source dividends, interest, rents, royalties and many other periodic payments. Compensation for personal services performed in the United States by a nonresident alien is generally subject to 30%, unless a rule or treaty exempts it.
• Not covered by chapter 3: portfolio interest meeting the requirements, bank deposit interest not effectively connected with a US business, and certain short-term original issue discount.
• Not US-source: pay to a nonresident alien for services performed outside the United States is not wages and is not subject to withholding.
• Different regime: a partnership's effectively connected income allocable to foreign partners is reported on Forms 8804 and 8805, not on Form 1042, and US real property sales by foreign persons fall under FIRPTA.

How to withhold and report, step by step

1. Get documentation before you pay. Ask each payee for Form W-9 (US persons) or the right Form W-8 (foreign persons). Without valid documentation, withhold the full statutory amount.
2. Check the form. The payee name, country of residence, tax identifying number where required, treaty article and signature must be complete. A Form W-8BEN generally stays valid from signing through the last day of the third succeeding calendar year, unless circumstances change. The payee must tell you of a change within 30 days.
3. Identify the income type and source. Match the payment to an income code and decide whether it is US-source.
4. Withhold the right rate. Use the treaty rate only if the payee is a treaty resident, is the beneficial owner and meets the treaty's requirements, including any limitation on benefits for entities.
5. Deposit the tax. Follow the deposit schedule in the Form 1042 instructions.
6. File Form 1042-S for each recipient and income type. Send copies to the IRS and to the recipient by the same March 15 date.
7. File Form 1042. This is the annual return that totals the withholding. A Form 1042-S is required even if tax was not withheld because of a treaty exemption.
8. Keep records. Keep the W-8 forms and supporting invoices with your payroll and tax records.

The IRS says withholding agents e-file Forms 1042-S, and Form 1042-S for 2026 must use the IRS Information Returns Intake System (IRIS), due March 15, 2027. The e-file threshold is 10 information returns in total.

Treaty rates for Canada and India

The IRS treaty table (Table 1, revised May 2023) shows these US withholding rates for residents of each country. The treaty text and its limitation on benefits article control, so we confirm before applying a rate.

For India, the 15% royalty rate also covers fees for included services under Article 12 of the treaty. The treaty with India gives 15% on dividends to a company owning at least 10% of the voting stock and 25% otherwise. See our US-India treaty guide and US-Canada treaty guide.

A worked example

Fox Valley Analytics Inc. in Aurora is a wholly owned subsidiary of a Canadian company. Hypothetical payments for 2026:

• Dividend of US$40,000 to the Canadian parent. With a valid Form W-8BEN-E claiming the 5% treaty rate, it withholds US$2,000. With no valid form it must withhold 30%, or US$12,000.
• Royalty of US$18,000 to an Indian licensor of software. With a valid treaty claim, 15% is US$2,700; otherwise 30% is US$5,400.
• Consulting fee of US$25,000 to a Pune contractor, for work done entirely in India. No US withholding applies because the services were performed outside the United States, but the company keeps the Form W-8BEN and an invoice showing where the work happened.

In January 2027 the company prepares one Form 1042-S per recipient and income type, and files Form 1042 by March 15, 2027.

Penalties and risks

The withholding agent is liable for the tax, interest and penalties if it fails to withhold. Late, incorrect or missing Forms 1042-S can bring information return penalties, and an incomplete Form W-8 can leave you unable to support a treaty rate. Our guide to foreign reporting penalties covers notices.

FIRPTA in brief

When a foreign person sells a US real property interest, the buyer is generally the withholding agent and must withhold 15% of the amount realized (10% for dispositions before February 17, 2016). A foreign corporation that distributes such property must withhold 21% of the gain. There are exceptions and a withholding certificate process, so a buyer or seller of Illinois property should get advice before closing.

Mistakes to avoid

• Paying first and collecting a Form W-8 later.
• Applying a treaty rate without checking residency, beneficial ownership and limitation on benefits.
• Skipping Form 1042-S when the treaty rate is zero.
• Using a Form W-8BEN after a change of circumstances, such as a move.
• Withholding on foreign-source service fees, or failing to withhold on US-performed services.

How we can help

We review the payments your US company makes abroad, collect the right W-8 forms, calculate withholding, and prepare Forms 1042 and 1042-S. For payments to Canada or India we coordinate with your Canadian CPA or Indian Chartered Accountant, including the foreign tax credit side. Our firm is based in the Aurora, Illinois area. See business tax returns and planning, cross-border tax and bookkeeping and accounting. The nonresident side is explained in US tax for nonresidents.

Frequently asked questions

General information only. It is not tax, legal, accounting or immigration advice for your situation, and rules change; confirm the current rules with the official source or a licensed professional in the relevant country.