How can payments to foreign vendors be determined as FDAP?

Payments to foreign vendors can be determined as FDAP (fixed or determinable annual or periodical) by following these steps:

1. Identify Payments to Foreign Vendors: Conduct a computer analysis of all payments to vendors. Look for indicators such as:
   • Address fields showing a country other than the USA, or blank fields.
   • State fields not showing a U.S. state, or blank fields.
   • City fields indicating a foreign city.
   • Zip codes not following the U.S. pattern (xxxxx-xxxx).
   • Foreign Employee Identification Numbers (EINs) starting with 98.
   • Foreign Individual Taxpayer Identification Numbers (ITINs) starting with 999 and the fourth digit being a 7 or 8.
   • Foreign vendor numbers or other identifiers in your accounting system.
2. Determine FDAP Income: Once all payments to foreign vendors are identified, select those which qualify as FDAP income. Common items of FDAP income include:
   • Compensation for personal services.
   • Dividends and dividend equivalent payments.
   • Interest.
   • Original issue discount.
   • Real estate mortgage investment conduit (REMIC) excess inclusion income.
   • Pensions and annuities.
   • Alimony.
   • Real property income, such as rents.
   • Royalties.
   • Taxable scholarships and fellowship grants.
   • Other taxable grants, prizes, and awards.
   • Sales commissions.
   • Distributable net income of an estate or trust that is FDAP income.
   • FDAP income distributed by a partnership.
   • Taxes, mortgage interest, or insurance premiums paid to a nonresident alien landlord by a tenant under a lease.
   • Publication rights.
   • Prizes awarded to nonresident alien artists, boxers, or professional golfers for activities in the United States.
3. Review Methodology: Ensure that the methodology used to characterize your expenses is accurate and consistent with IRS guidelines.
4. Source Determination: Determine whether the FDAP income is U.S. sourced. Review all applicable documentation, such as invoices, engagement letters, and contracts, to ascertain the source of the income. Note that if the source of an amount cannot be determined at the time of payment, the payment will be treated as U.S. sourced (Treas. Reg. 1.1441-2(a)).

By following these steps, you can accurately identify payments to foreign vendors that qualify as FDAP income and determine their U.S. source status for withholding and reporting purposes.

Sources:
Publication 515 (2024)
§ 1.1441-1. Requirement for the deduction and withholding of tax on payments to foreign persons.
§ 1.1441-2. Amounts subject to withholding.
§ 1.1441-3. Determination of amounts to be withheld.
T.D. 8734