Navigating Form 1042-S and International Tax Compliance for Music Companies and Artists

Tax compliance can be tricky for US-based music companies working with international artists, especially when dealing with tax treaties and IRS forms like Form 1042-S. This blog will simplify the key requirements, examine common pain points, and offer practical tips for staying compliant and avoiding risks. 

International tax compliance is a complex arena for music companies and artists. For US-based businesses working with international talent, the challenges multiply with cross-border payments, tax treaties, and the intricacies of collecting and filing IRS forms like Forms 1042-S. For artists, navigating these processes can be equally daunting, especially when facing double taxation risks and sourcing rules.

Understanding the requirements of IRS Forms W-8BEN, 8233, and 1042-S is critical for paying agents to ensure compliance while minimizing risks for themselves and the artists they work with. Beyond tax forms, payers must also address other common international tax compliance issues, such as navigating tax treaties, proper income sourcing, and ensuring accurate reporting across multiple jurisdictions.

By recognizing the challenges artists face, music companies can improve their processes, foster trust, and offer a better overall experience. This blog provides actionable insights to help navigate these challenges effectively, finishing off our series on navigating tax compliance issues in the music industry, taken from conversations with Jessalyn Dean, CPA.

What is IRS Form 1042-S, and when is it required?

Let’s start with the form used to report US-sourced payments made to foreign individuals or entities: Form 1042-S. For paying agents in the music industry, this typically includes US-sourced royalties, services performed in the US, and other income subject to US withholding tax. Understanding when and how to use this form can prevent costly errors for both your business and the artists you work with.

Here are some key points to remember in regards to Form 1042-S:

• US-sourced payments only: Only income sourced within the US is reportable on Form 1042-S. Payments sourced elsewhere are not subject to this reporting. In the case of music royalties, only royalties generated when music is streamed or consumed by listeners in the United States are reportable on Form 1042-S. Payments for non-US-sourced royalties—when music is streamed or consumed by listeners outside of the United States—are not subject to US withholding taxes but may still be taxed in the country where the music is consumed. 
• Accurate data matters: Both overreporting and underreporting can lead to unnecessary penalties for you and your artists. Ensure you’re not reporting payments on Form 1042-S that aren’t required or overlooking payments that should be reported to avoid compliance complications. Keeping clean, detailed records is vital in ensuring smooth tax reporting. 
• Artists still need information: Even if a payment isn’t reportable on Form 1042-S, providing detailed payment statements—with all of their royalties and the countries they’re sourced to—helps artists manage their own compliance in other jurisdictions.

By collecting accurate data and focusing on clear reporting, music businesses can streamline the 1042-S process while reducing risks for themselves and their artists.

Tax treaties and how they affect international artists

Tax treaties play a critical role in determining the withholding rates for foreign artists. These treaties help prevent double taxation and ensure fair treatment for income earned across borders.

Navigating tax treaties as a paying agent

To verify an artist’s eligibility for tax treaty benefits, paying agents should:

1. Review contracts: Carefully evaluate whether the income qualifies as royalties, services, or some other type of income. This step ensures the application of the correct withholding rules, helping to streamline compliance and avoid potential penalties. To classify as a royalty for tax purposes, the artist typically must have ownership rights to the intellectual property (IP) that generates the royalty and the IP must already be created. Artist advances, for example, are commonly reported as services income rather than as royalties for this reason.
2. Collect proper forms:
   • For US-sourced royalties income: Use Form W-8BEN (or Form W-8BEN-E for entities). This form establishes the individual’s foreign status and eligibility for tax treaty benefits, which can reduce the default withholding rate of 30%. By providing accurate and up-to-date information on Form W-8BEN, artists ensure that paying agents withhold the correct amount, preventing overpayment of US taxes. Automation solutions like Trolley can help expedite this process and remove the risk of manual error. 
   • For US-sourced services income: Use Form 8233 to apply for reduced withholding rates under a tax treaty for services performed in the US. Form 8233 applies to personal services income, making it suitable for performers, producers, or others earning US-based service income. This form requires submission to the IRS for review and approval, and payments can be withheld at the reduced rate only after IRS confirmation or after the standard 10-day processing period if no response is received.
   • Data collected from both Form 8233 and Form W-8BEN is necessary for determining the correct amount of withholding and reporting on Form 1042-S.
   • Be aware of unique situations that artists may face, which could require the collection of other less common types of forms like the Form W-8ECI or Form W-8IMY.
3. Monitor the types of payments you make to your artists: Collecting an IRS form might seem like a one-time task upfront, but the type of payment you make to an artist can change over time. For example, if you initially collect a Form W-8BEN for royalty payments but later begin paying the artist for services or performances, you’ll need to collect new documentation—such as Form 8233—that applies specifically to those types of payments. Regularly reviewing the nature of your payments can help ensure compliance and avoid errors.
4. Consult tax professionals: Build a network of tax advisors who specialize in the music industry and have experience navigating international income and tax compliance for artists. Vet these advisors for their expertise, reputation, and responsiveness to ensure they can provide timely and accurate guidance to help your company stay compliant and avoid costly mistakes. You can also provide a list of tax professionals to the artists you work with to help make their tax compliance easier. 

Common challenges

• Misclassification of income: Incorrectly categorizing payments can lead to incorrect withholding. For example, treating royalties as services income or vice versa can result in unnecessary withholding or penalties for underwithholding. Underwithholding leads to penalties for the paying agent, as they are responsible for the unpaid tax, while unnecessary overwithholding forces the artist to file a tax return to claim back the money from the government—often incurring additional costs that may exceed the potential refund.
• Inconsistent rates: Withholding at the wrong rate due to misunderstanding treaty terms or collecting the wrong form can be costly. For example, if a company fails to withhold enough from an artist’s income, it may be liable for the remaining amount to the IRS. If the company doesn’t provide the correct form to the artist, the artist may not file a US tax return when required, potentially resulting in them owing the IRS an estimated amount without any deductions.
• Double taxation: Double taxation occurs when the same income is taxed by two different countries. This is a common challenge for both US- and non-US-based artists. In these situations, the artist needs to work with their tax advisor to determine which country has the primary right to tax the income, often based on tax treaty terms. If taxes are withheld in both countries, the artist may be entitled to a refund or credit for the taxes paid in the foreign country, usually by filing a US tax return or a reclaim form in the other country. However, if the additional tax is relatively small, the artist might be hesitant to hire a tax advisor to navigate the process. Ensuring the correct withholding at the outset can help avoid this issue and simplify the process for both the artist and the company.

Investing in systems to track treaty eligibility and withholding rates and communicating with artists about how their income is classified and taxed are great ways to reduce friction come tax season.

Unique challenges for US citizens living abroad

Understanding the tax challenges faced by US citizens living abroad is essential for music companies that work with US artists in this situation. US citizens are taxed on their worldwide income, regardless of where they reside. 

And this just doesn’t apple to US citizens—US green card holders face unique tax challenges as well. US green card holders remain taxed as though they live in the US, even when they leave. Importantly, simply allowing the green card to expire does not terminate US tax obligations. To end US taxation on worldwide income, individuals must formally renounce or turn in their green card. Many people believe that letting the green card expire ends their US taxpayer status—this is incorrect and can lead to significant issues if not properly addressed.

Tax treaties and how income is characterized can significantly impact where and how taxes are paid, which is crucial for staying compliant and avoiding double taxation. 

When it comes to income earned abroad, it’s important to determine the “character of income” and “source of income” for tax purposes. Services income (the “character”) is typically sourced based on where the work is physically performed. For example, if a US artist living abroad performs a concert in another country, that income is generally sourced to the country where the performance occurs. Royalties, on the other hand, are generally sourced based on where the music is consumed by the end listener. Understanding the source and character of the income is especially important to US citizens living abroad so that they can properly allocate the income to the correct country for taxation purposes, claim any exemptions from tax on that income, and claim foreign tax credits on any double-taxed income. 

For example, consider a US citizen living full-time in Country X who earns royalties from listeners in the US and earns services income for performing a show in Country X. 

• Assuming the paying agent of both of these income streams is a US paying agent, then they will collect a valid TIN on a Form W-9 from the artist for all of the payments and be exempt from any withholding taxes. Even though the US citizen lives abroad, they will receive a Form 1099 at the end of the year reporting payments to them (and not a Form 1042-S).
• Country X wants to tax all of this income because the artist is a full-time resident of Country X, even though only the services income is sourced to Country X. The US also wants to tax all of this income because the artist is a US citizen, even though only the royalty income is sourced to the US. 
• The artist would work with their tax advisor to address the situation. The ideal outcome, if the artist meets the criteria of the tax treaty, is that the artist files and pays their taxes first in Country X. Country X would have full taxing rights on the services income as the services were performed in Country X. Country X would calculate tax on the royalty income, but give a foreign tax credit for 10% taxes that the US gets to collect under the tax treaty between the US and Country X because the royalty income was US-sourced. After filing their taxes in Country X, the artist then files their US taxes. They would calculate tax on both the royalty income and the services income, and then deduct a foreign tax credit for taxes paid to Country X. In order to claim this foreign tax credit, the artist would need to “treaty resource” the royalty income to Country X only above and beyond the royalty income related to the 10% tax treaty rate. Filing the correct paperwork is crucial.

Additionally, US citizens living abroad may be eligible to exclude up to approximately $126,500 (for tax year 2024) of their earned services income from US taxation under the Foreign Earned Income Exclusion (FEIE), provided they meet certain requirements. One of the benefits of the FEIE is that it simplifies the tax calculation process shown in the example above. However, this exclusion does not apply to royalties or to US-sourced services income, highlighting the importance of correctly classifying and sourcing income to ensure proper tax treatment.

Music companies working with US artists living abroad should consult with tax advisors who are familiar with international tax laws and treaties. Proper guidance can help avoid double taxation and simplify the tax compliance process, ensuring both your company and your artists stay on track during tax season.

Streamline your tax compliance and elevate your recipient experience

Tax compliance in the music industry is complex, but understanding the nuances of IRS forms, international tax treaties, and income character and sourcing rules can make a significant difference. For paying agents, prioritizing accurate tax withholding, precise reporting, and clear payment data for artists fosters trust while reducing risks. For artists, consulting tax advisors and staying informed about their obligations ensures smoother compliance.

Trolley’s tools simplify international tax compliance, enabling music companies to focus on what matters most—creating great experiences for the artists they work with. 

Our automated payout and reporting solutions free finance teams from time-consuming manual tasks like form collection and distribution. By ensuring tax information is validated and tailored to each income stream, Trolley helps music companies stay compliant while delivering a seamless experience to their artists.

With Trolley, you can automate payout and tax processes, ensure accurate tax reporting, and stay compliant year-round.

Ready to streamline your royalty payouts and tax compliance? Join the likes of SoundCloud, United Masters, Soundrop, CD Baby, and more by getting in touch today.

*** Legal disclaimer

The information provided in this article is for informational purposes only and should not be considered legal, financial, or compliance advice. It is not intended to replace the advice of qualified professionals who are familiar with your specific circumstances. Compliance with IRS regulations is the responsibility of your organization.

Trolley’s platform is designed to assist with payment and tax reporting processes but does not constitute legal or compliance certification. We recommend consulting with your legal, financial, or compliance advisors to ensure that your systems and processes meet all applicable requirements. For questions about Trolley’s features and how they align with your compliance needs, please contact our support team.