I told her the company has nothing to withhold when it pays its own owner, and the definition of a withholding agent does not mention ownership

A reader in Madrid asked whether her US LLC had to withhold anything when it paid her, and I told her no, because she is the owner and it is her money. I was wrong, or at least I answered a question of fact with a matter of opinion, and it was bad advice because the answer does not depend on who owns the company at all.

The phrase to search for is form 1042-s withholding for a foreign owned llc, and the answer sits in 3 short pages the IRS publishes about withholding agents. Reading all 3 after her question took most of an evening, and the sentence that changed my mind is about who counts as an agent rather than about tax rates.

You can be a withholding agent without knowing the words

I had pictured a bank. The definition is wider than that. “You are a withholding agent if you are a U.S. or foreign person that has control, receipt, custody, disposal, or payment of any item of income of a foreign person that is subject to withholding.”

Not only a bank, and not only a payroll provider. Any person or entity with control or payment of that income qualifies. The same page lists what an agent can be: an individual, a corporation, a partnership, a trust, an association “or any other entity”, which is broad enough to include a single member LLC run from a kitchen table in Lisbon.

Then the line I would put in bold if it were my page: “You may be a withholding agent even if there is no requirement to withhold from a payment or even if another person has withheld the required amount from the payment.” The status is not a consequence of owing tax. It arrives first, and the tax question comes after it.

The liability is personal, and it survives the tax being paid

This is the part that made me rewrite my answer. I sent a correction the same night. “As a withholding agent, you are personally liable for any tax required to be withheld,” and that liability “is independent of the tax liability of the foreign person to whom the payment is made.”

If the agent does not withhold and the foreign payee does not settle up, then “both you and the foreign person are liable for tax, as well as interest and any applicable penalties”. The tax itself is collected only once, which sounds like relief until you read the next clause: if the foreign person does pay, the agent “may still be held liable for interest and penalties for your failure to withhold”.

So the downside is not symmetrical, and the asymmetry is the whole reason to care. Doing it right costs paperwork and 2 forms. Doing it wrong leaves a bill that does not disappear when everybody else has paid theirs, and for a company whose owner and agent are the same person, both halves of that arrangement land in the same lap.

The rate, and where 30 per cent comes from

The headline number is blunt. The page puts most types of US source income received by a foreign person at a tax of 30 per cent, and adds that a lower rate or an exemption can apply where the Code provides one, or where a treaty between the payee’s country and the United States does.

I would learn the name of the regime before the rate. It has a statutory home. NRA withholding refers to withholding under sections 1441, 1442 and 1443 of the Internal Revenue Code, and it “describes the withholding regime that requires 30% withholding on a payment of U.S. source income and the filing of Form 1042 and related Form 1042-S”.

3 things sit outside it, and knowing that saved me an argument with an accountant. NRA withholding does not include withholding on dispositions of US real property under section 1445, withholding on a foreign partner’s share of effectively connected income under section 1446, or withholding under section 1446(f) on certain dispositions of partnership interests. They are different regimes with different forms attached.

What the 3 pages cost me to read, and what they are worth

I printed all 3 and marked them with a pencil, which is not something I usually do with a tax page, and the marks ended up clustered in 1 paragraph rather than spread across the set.

The 3 pages together run to maybe 2,000 words. It took me 2 hours, mostly spent going back over 1 paragraph about liability, and at the end of it I had changed my answer to a reader and found 2 sentences I had been contradicting without knowing.

That ratio is the argument for reading them, because the alternative to reading them is an opinion, and an opinion from a person who is both the payer and the payee has no independent value at all. Every number in this letter comes from those pages: the 30 per cent, the 3 statutory sections, the 3 regimes that sit outside NRA withholding, and the 1 form that carries the effectively connected claim.

What I should have told Madrid

That the ownership question is the wrong question. The sequence is what matters, and it has 3 steps. First, whether the company has control or payment of income belonging to a foreign person, which for her company is plainly yes, because she is a foreign person and the company pays her.

Second, and this is the step I skipped. Whether what it pays her is US source income subject to withholding which is a question about where the income comes from and what kind it is, not about her passport. That is the step I skipped, and it is the step that decides whether anything is actually due.

Third, the rate. Whether the Code or the treaty between her country and the United States reduces it, and whether the exemption for income effectively connected with a US trade or business applies, which is claimed on Form W-8ECI rather than assumed.

Where her payments land in that sequence is not something this letter can settle, and neither can anybody who has not read her contracts. What I can say is that the first step is answered by facts about her company rather than by anybody’s opinion, and that getting it wrong costs interest and penalties that survive her own tax being paid in full.

Why this catches non residents specifically

There is a reason this lands harder on people outside the country, and it is structural rather than unfair. An owner who lives in the United States meets this machinery from the other side, as the person being paid domestically, with a W-9 and an ordinary payroll or distribution. From outside, the same company is simultaneously the payer and a foreign recipient, and the paperwork that a domestic company would send to somebody else has to be produced by the company for its own owner.

Both roles sit in 1 company and often in 1 person, which is why the paperwork feels circular when you first meet it: the entity issues a statement to its own owner about money it has already sent, and the statement exists so that a third party, the IRS, can see a transaction between 2 parties who both already know about it. That is an odd thing to arrange and I find it hard to explain without a diagram. It is also the reason the question sounds absurd the first time anybody asks whether they must withhold from themselves. The answer is that the company is not you, even when the tax return treats it as if it were.

My guess is that most single owner companies in this position never look at it, because nothing in a bank account or a bookkeeping tool asks the question, and nobody sends a letter in the first year. That is a guess about behaviour, not a statement about the rules.

Questions we get

These come up every time. I answer them in this order now. They arrive in almost every version of this conversation, and 2 of them are the same question asked from different directions.

What makes somebody a withholding agent? Control, receipt, custody, disposal or payment of an item of income of a foreign person that is subject to withholding. The status applies to a US or foreign person, to individuals and to entities, and it applies even when no withholding turns out to be required, which is the 1 sentence I would read twice before deciding that the question does not concern your company at all.

What does nra withholding actually cover? Withholding under sections 1441, 1442 and 1443, at 30 per cent on payments of US source income to foreign persons, with Form 1042 and Form 1042-S attached to the regime. It excludes FIRPTA under section 1445 and partnership withholding under sections 1446 and 1446(f), which matters more than it sounds, because somebody who reads a summary of one of those regimes and applies it here will arrive at both the wrong rate and the wrong form while believing they have done the homework.

When is form w-8eci the right form? When the foreign person claims that the income is effectively connected with the conduct of a trade or business in the United States, which is the exemption the IRS page names for that situation. Whether your income qualifies is a question for somebody who has read your contracts. Not for a letter like this one.

Is 30 per cent withholding always the rate? 30 per cent is the default for most types of US source income received by a foreign person. A Code section or a treaty can reduce it or remove it, and the reduction is claimed rather than granted automatically, which in practice means a form arriving before the payment rather than an argument arriving after it, and that ordering is the difference between a rate of 0 and a rate of 30 on money that has already left the account.

What is us source income for a company like mine? That is the 1 question I cannot answer in a letter. It turns on the type of income and where it arises. This is the point where I would pay an accountant rather than read a page, and an hour of that costs less than the interest on a year of not asking.

A short digression about the word agent

The vocabulary does real damage here. Agent suggests somebody acting for you: a lawyer, a broker, a registered agent in Delaware for 100 dollars a year. Here it means the opposite, a person the government has made responsible for somebody else’s tax, and the word does a lot of damage on the way in. I still think about how confidently I told Madrid no, using a definition of agent I had picked up from company formation rather than from the tax code. Anyway, back to the sequence.

What is not settled here

The filing deadlines for Form 1042 and Form 1042-S. The page does not carry them, so they stay out of this letter instead of arriving from memory, which is how half the wrong dates in this subject get published.

The penalty amounts are the second gap. The page points at a general penalties section instead of naming figures, and I have not found a table I would quote in a letter people might act on.

Whether her payments are US source at all. I do not know, she does not know yet, and the honest version of this letter ends with the name of the question rather than with an answer to it.