CBIZ
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November 21, 2024

IRS to Ramp Up 1042 Audits for Managed Funds—Are You Ready?

Table of Contents

On Sept. 26, 2024, the Securities Industry and Financial Markets Association (SIFMA) and the Wall Street Tax Educational Corporation hosted the 2024 Global Tax Reporting Symposium in New York, featuring in-depth discussions on pressing topics such as international issues, enforcement, AI, digital assets and the evolving tax compliance landscape. The event brought together government experts who provided critical updates on the complex tax regimes firms are facing.

As we look ahead to 2025, we have highlighted five key takeaways and areas of IRS focus, particularly around audits of Forms1042/1042-S.

IRS Hiring Spree in the Form 1042 Space

The IRS is undergoing an unprecedented hiring spree in 2024, focusing on expanding resources to increase audits of complex partnerships.

Increased Form 1042 Audits of Managed Funds

Managed funds can expect to see a substantial increase in the issuance of notices. Traditionally, the IRS audits targeted banks, but there is now a clear shift towards managed funds, signaling a significant change in audit priorities for 2025.

IRS Use of Data Analytics to Tie Form 1042 Data With Other Returns

IRS examinations are about to become much more comprehensive, with data analytics playing a pivotal role in identifying anomalies. Auditors will link Form 1042 data to Schedule K-1 information from Form 1065 and Form 1120 interest expense.

IRS Review of Internal Policies and Procedures Documents

Additionally, the IRS will request copies of Chapter 3 and Chapter 4 policies and procedures from firms at the outset of an examination. The IRS will be reviewing these internal documents and citing taxpayers’ own guides in response to Information Document Request submissions.

Mandatory Form 1042 E-Filing Requirements

New electronic filing requirements for Form 1042 will take effect, impacting the following:

  • Withholding agents that are financial institutions
  • Withholding agents that are required to file 10 or more information returns
  • Partnerships with more than 100 partners, regardless of the number of information returns being filed

What You Can Do Now to Prepare for a Potential Form 1042 Audit

Managed funds should be undertaking efforts now to prepare for an upcoming Form 1042 audit. Key steps include:

  • Reviewing and Validating Investor Forms W-8
  • Soliciting New Forms W-8, Documentary Evidence and Retroactive Affidavits
  • Maintaining Investor Tax Documentation in a Secure Software Solution
  • Leveraging Data for Accurate Form 1042/1042-S Filings
  • Updating Internal Policies and Procedures

Validation involves more than checking expiration dates. Validation also includes curing U.S. indicia, confirming tax treaty claims have been filled out properly and ensuring there are no gaps in documentation that would necessitate the collection of a retroactive affidavit.

Developing and implementing a process for reaching out to investors to collect new Forms W-8 to cure documentation shortfalls or retroactive affidavits will ensure you have the documentation you need upon audit.

Organizing investor tax forms, documentary evidence and important correspondence to the investors’ records in a centralized system streamlines audit preparation. Keeping these records stored securely in one place ensures efficient access during an audit.

Digitizing data from tax forms simplifies global reporting obligations and ensures that you use the same data across all your reporting (e.g., this ensures that the same address is used for an investor on the Schedule K-1, Form 1042-S and CRS reports).

Reviewing internal policies and procedures documents to ensure they clearly worded and accurately reflect your organization’s most recent processes, highlighting which tasks are delegated to third-party service providers and outlining your internal sign-off chain will lead to a better overall audit experience.

Need Assistance?

For further information about these evolving requirements and how they may impact your firm’s compliance strategy, please contact Heather Brown or Meghan Anderson. Our team can guide you through the complexities of IRS audits and electronic filing mandates and help ensure your business is prepared for 2025 and beyond.

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