Interest payments to a non resident

[MIKEPIN]

Florida - USA.

I have a friend that has a Dutch passport. He has not lived there in 20 years and does not pay taxes there. For about 10 years he lives and works on a cruise ship. He showed me a confirmation from the cruise line. He is convinced that he does not have to pay taxes.

He gave me money to invest in a property. I pay him 4% interest.

I believe I have to report payments to him on a 1099 INT form. But he has no SSN.

What are my legal requirements?

 

[LdiJ]

Florida - USA.

I have a friend that has a Dutch passport. He has not lived there in 20 years and does not pay taxes there. For about 10 years he lives and works on a cruise ship. He showed me a confirmation from the cruise line. He is convinced that he does not have to pay taxes.

He gave me money to invest in a property. I pay him 4% interest.

I believe I have to report payments to him on a 1099 INT form. But he has no SSN.

What are my legal requirements?

In my 30 plus year of practice, I have not seen this particular question arise.

I don't think that he is subject to US income taxes. He is not a US citizen or resident, he is not physically present in the US, and he is not earning money in the US. Yes, a US citizen (apparently) is paying him interest on a loan, but it is not an investment per se.

From the instructions for form 1099 INT:

"Interest excluded from reporting. You are not required to file Form 1099-INT for interest on an obligation issued by an individual, interest on amounts from sources outside the United States paid outside the United States by a non-U.S. payer or non-U.S. middleman, certain portfolio interest, interest on an obligation issued by an international organization and paid by that organization, and payments made to a foreign beneficial owner or foreign payee. See Regulations section 1.6049-5 for more information. Other exception."

Based on that, I think that it's not your problem whether or not your Dutch friend pays income tax.

 

[FlyingRon]

And his employer is almost certainly not a US entity.

 

[MIKEPIN]

Okay. Understood. I just wanted to make sure, I can deduct it as an expense and I do not have to withhold anything on the interest payments.

 

[davew9128]

Disagreeing with the other responses here. You might and probably do have a withholding and reporting requirement on the interest income on Form 1042-S. This is US sourced income, so unless he qualifies for a treaty exception under the treaty for any particular nation he is a resident of (which is probably none), then you need to follow the instructions for the form.

 

[Taxing Matters]

In my 30 plus year of practice, I have not seen this particular question arise.

I don't think that he is subject to US income taxes.

Yes, he is almost certainly subject to U.S. income tax here. First, if he's a U.S. citizen or resident he is of course taxed on the interest. The OP does not clearly say he's not a U.S. citizen or resident (which would include a green card holder). That's important information to know.

However, it is implied he is a non resident alien (NRA) for tax purposes. He is receiving U.S. source interest income, which is a type of fixed, determinable and periodic income (FDAP). FDAP includes interest, rents, dividends, and most other income other than capital gains and income from personal services performed in the U.S. The tax law provides that U.S. source FDAP income paid to NRAs is taxable at a flat rate of 30% unless there is some exemption that applies.

The banking industry got an exemption into the Code so that interest paid by U.S. banks to foreign persons is exempt, but interest paid by an individual to a non resident alien (NRA) is not excluded from tax under the Code. So unless he has a treaty exemption he's subject to the tax. In general U.S. tax treaties do not provide exemption from interest, though perhaps one or two do. (I've not read all of them in detail and some older treaties do not conform to the model treaties the IRS has used the last two decades to negotiate treaties. The model treaty does not exempt interest.) We don't know in which country he's considered tax resident since all we know is that he holds a Dutch passport. That would be important to know to determine if any treaty exemption applies.

From the instructions for form 1099 INT:

"Interest excluded from reporting. You are not required to file Form 1099-INT for interest on an obligation issued by an individual, interest on amounts from sources outside the United States paid outside the United States by a non-U.S. payer or non-U.S. middleman, certain portfolio interest, interest on an obligation issued by an international organization and paid by that organization, and payments made to a foreign beneficial owner or foreign payee. See Regulations section 1.6049-5 for more information. Other exception."

Correct, the interest here would not be reported on a Form 1099-INT. Rather, as davew9128 pointed out, it's reported on Form 1042 & 1042-S. The U.S. person paying the interest generally has the obligation to withhold the 30% tax from each interest payment (or a reduced rate if an applicable treaty has a reduced rate, which some treaties do) and remit that to the IRS. See the IRS page on Income subject to NRA withholding. The failure to do that can make the U.S. person personally liable for the tax that was supposed to be withheld and the U.S. person may be hit with penalties, too.

For more information, see IRS publication 515, which covers the withholding requirements for FDAP income in considerable detail. See also Publication 519 which explains what income is taxable U.S. source income for nonresident aliens, with specific information on interest payments.

 

[MIKEPIN]

Thank you so much. He is not a US citizen.
He lives on a cruise ship and does not pay taxes anywhere. I have a confirmation from the cruise ship on this.

Now, if I got Euros from him in the Netherlands and paid the interest over there on an account, I still need to withhold if I want to use the funds for my US property and want to deduct the interest payments here?

 

[Taxing Matters]

Thank you so much. He is not a US citizen.
He lives on a cruise ship and does not pay taxes anywhere. I have a confirmation from the cruise ship on this.

Now, if I got Euros from him in the Netherlands and paid the interest over there on an account, I still need to withhold if I want to use the funds for my US property and want to deduct the interest payments here?

The interest is considered US source interest based on the residence of the person paying the interest. So if you are a US resident, taking a trip the Netherlands to pay the interest wouldn't change things; you still have to report and withhold on the interest paid because the interest is US source and you are paying it to a nonresident alien.

 

[MIKEPIN]

Thank you! That was great help!

 

[Taxing Matters]

Thank you! That was great help!

You're welcome. Glad the information you received on this forum was useful.