By law, foreign workers and corporations who engage in a trade or business within the U.S. are taxed at a graduated rate on income that’s connected with the work they do within the U.S. Also, withholding agents are required to withhold tax at 30% of U.S.-source income paid to a foreign person or entity. However, withholding isn’t required on income that is connected with the conduct of a trade or business within the United States if that income is included in the gross income of the recipient under Sec. 871(b)(2) for the tax year.
In Chief Counsel Advice (CCA) 201428007, the IRS issued final regulations on a withholding agent’s responsibility in regard to foreign workers and corporations earning income in the U.S.
Because withholding agents often have no way of verifying whether or not a person or corporation is truly exempt from withholding, agents are allowed to rely on the person or corporation’s claim via a Form W-8. (The Form W-8 must include the taxpayer identification number of the person whose name is on the form and must represent, under penalties of perjury, that the amounts for which the certificate is furnished are connected with the conduct of a trade or business in the United States and are includable in the beneficial owner’s gross income for the tax year.)
However, if the IRS becomes aware that the exemption claim is incorrect, it can notify the withholding agent. And the withholding agent is responsible for withholding 30 calendar days after the notice is received. A withholding agent is liable for tax, interest, and penalties if it fails to withhold tax as required.
Also note that the IRS has stated that if the withholding agent has actual knowledge or reason to know that the claim of exemption for effectively connected income is incorrect, it must still withhold, in spite of what’s claimed on a Form W-8 by the foreign person or corporation.
The final regulations are effective for tax years ending after July 20, 2014, and may be applied to any previous years for which the statute of limitation is still open.