The Reconciliation of 1042-S Forms are the IRS' Focus for the Upcoming Certifications
The Qualified Intermediary (QI) Agreement is concluded between the Internal Revenue Service (IRS) and non-U.S. banks. It includes, in particular, provisions for customer documentation and for the withholding and payment of U.S. withholding tax due on income from U.S. securities. It also specifies how the banks, which now act as Qualified Intermediaries (QIs), process the aggregated tax information from the upstream custodian (so-called received 1042-S forms) and transmit it to the IRS (so-called issued 1042-S forms).
In principle, it seems very simple and obvious that the respective QI can only forward "reportable amounts" to its customers that it has previously received from its custodian. However, it has been known for years that it is very difficult to perform a reconciliation of the 1042-S forms due to, among other things, different data sources, 871(m) regulations, timing differences in posting and also reports with an incorrect QI-Employer Identification Number (QI-EIN). Now, the IRS has made reconciliation a key topic for the 2018 to 2020 certification period, requiring that each QI certification be accompanied by the appropriate 1042-S reconciliation for the calendar years being certified. This should then serve as the basis for deciding whether certification is successful. Any discrepancies or inconsistencies identified therein will be questioned by the IRS and, if breaches of duty by the QI are identified, could result in hefty fines.
Are you prepared for this? Are you already performing a reconciliation that can be provided to the IRS for review and reconciliation against their data? At many institutions, we see that the reconciliation is performed manually, which leads to inherent errors when there are often over 100 forms to be analyzed. This manual execution is challenging for many banks and can be very time consuming with sometimes millions of individual payments.
The Best Way to Check 1042-S Forms
The Reconciliation Data Cruncher supports you in checking the plausibility and with reconciling all 1042-S forms for differences.
In this web-based tool, we have included the experience of the last 20 years of the QI regime and offer you not only a simple reconciliation of your reports, but also detailed plausibility checks. The intuitive user interface allows you to use the tool independently without time-consuming software training, and the integrated storage of changed fields can replace your previous manual reconciliation.
The contents of the reports are extracted by the software and converted into a machine-readable format. Typing out the forms is no longer necessary, simple transmission errors are avoided and you and your employees can concentrate on other tasks.
By reading out all available data fields and performing over 50 plausibility checks per form, we support you beyond the mathematical reconciliation required as a minimum to uncover and challenge inconsistencies.
Automatic aggregation and reconciliation of the received and issued reportable amounts/taxes withheld form the minimum reconciliation required by the IRS for each year of the certification period. Based on experience developed over years, identified differences are classified and prioritized in order to perform the subsequent detailed analysis in a targeted and efficient manner.
Our solution comes with a customizable letter text for the QI certification to the IRS and a total extract of the used data.
Compliant by Design
Comments and changes are visible at any time and can be evaluated in the summary. This allows the tool to be integrated into the banking process using the principle of dual control.
The price is an annual fee for the tool usage. All subsequent years starting from the 2nd certification period (2018) can be checked with our tool. New forms will be installed and made available as soon as possible.
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Qualified Intermediaries: Explained
Relevant for the applicability of the treaty are all customers who have U.S. securities in their portfolio that generate income (i.e. interest or dividends). The QI determines the tax residency of its customers and the applicable double tax treaty, applies the required tax rate to the income and regularly remits the withheld tax to the U.S. Internal Revenue Service (hereinafter referred to as IRS). Finally, annual reporting must be made separately by customer group and type of income, among other things, on Form 1042-S. Approximately 50 individual items of information must be reported on the form.
Why was the QI contract made?
As of January 1, 2001, the U.S. Internal Revenue Service (hereinafter referred to as IRS) required financial institutions worldwide to enter into a contract (hereinafter referred to as QI contract) that includes terms and conditions for documenting and monitoring customers and withholding tax on U.S. income. The starting point for the initial introduction in 2001 was that the U.S. assumed that many U.S. citizens had accounts/deposits with foreign banks and were not properly disclosing them on their tax returns (and thus avoiding taxes). This regulation therefore forms the basis for additional global tax transparency policies that exist today, e.g. FATCA (Foreign Account Tax Compliance Act), CRS (Common Reporting Standard)/AEOI (Automatic Exchange of Information).
In which way are FACTA and the Qualified Intermediary Agreement connected?
The contents of this contract were fundamentally revised as of 01.07.2014 and expanded to include various requirements from the FATCA regulations. The term of the current contract ends on 31.12.2022 and can only be extended by the QI itself via the IRS online portal. The previously known procedure of the periodic external audit (formerly QI audit; today Periodic Review) and the associated application for an audit exemption (so-called waiver) has been abolished with the new contract and the QIs are obliged to implement an internal "Compliance Procedure" (see Section 10 of the Revenue Procedure 2017-15). QI Qualified Intermediary is an intermediate custodian that has entered into a withholding agreement with the IRS.
What are the rights and obligations of Qualified Intermediaries?
QI's have the obligation to implement a compliance program in accordance with the QI Agreement, the obligation to properly document customers in accordance with the guidelines provided by the IRS. Furthermore, the obligation to comply with the regulations in the QI or private law agreement and the attachments applicable to the respective domiciliary countries to take into account national legitimation and documentation rules (attachments), the obligation to inform the upstream QI immediately of changes in its own QI status by means of a W-8IMY, act as a paying agent ("withholding agent") under IRC Chapter 3 (non-U.S. persons), Chapter 4 (FATCA) and Chapter 61 (U.S. persons) and to pay the withheld taxes to the IRS accordingly in full and on time. Lastly, to comply with the relevant reporting obligations (1042, 1042-S, 945, 1099), and meet the FATCA requirements applicable to it.
What is the role of a Responsible Officer(RO)?
The QI must appoint a Responsible Officer (RO) with sufficient authority (e.g., directive rights, audit and review) to perform the RO's duties and ensure compliance with QI compliance program requirements. The RO must be registered as an RO on the QI application and in the IRS's Account Management System. The primary responsibility of the RO QI (or delegate) is to establish an appropriate QI/FATCA compliance program that meets the requirements of Section 10 of the QI Agreement. In order to be able to fulfill these duties and, in particular, to determine the adequacy and effectiveness of the internal control system; they must subject it to a regular audit. The RO QI must act as the contact person for all QI relevant topics or requests regarding further documentation or additional review measures vis-à-vis to the IRS. He/she is responsible for the topic towards the IRS, is authorized to issue instructions to the relevant areas with regard to implementation and any corrections, and ultimately forms the final decision-making authority.
What is a QI Self-Certification?
In accordance with Section 10.03 of the QI Agreement, the Responsible Officer must make a so-called "periodic certification" to the IRS every three years. An important component of this is the certification of internal controls, whereby a distinction is made between a limited and an unlimited certification. A limited certification is required if there is either a so-called breach of contract (Event of Default) or a so-called material failure, which has not yet been remedied when the certification is submitted. The definition of material failures and breaches of contract are regulated in the QI contract, but contain various discretionary powers, which is why it is crucial to have comprehensible documentation on the exercise of these discretionary powers. In addition, the RO must document in writing all procedures, processes, reports, or certifications used to certify internal controls.
How is the sensitive data protected in the "Reconciliation Data Cruncher"?
- The entire content of the tool will be completely deleted daily at the following time: 2 AM (UTC+1) Central European Time. Subsequent recovery is not possible. The data is thus stored for a maximum of 24 hours.
- There is an import/export functionality to save the work status and continue the activity at the same place at any time. All information stored in the tool is saved. The zip file is encrypted with a password and cannot be changed.
- The product is a PwC inhouse PaaS Solution with Security Clearance for Financial Sector Audit Engagement.
- Client separation through separate container instances.