For qualified intermediaries (or QIs), pooling is an important feature of the US tax system that they should be taking advantage of. You see, it gives QIs the unique ability to pool their client’s US assets for the purpose of both withholding and reporting. But in some situations, they may need to de-pool a client, which can create all sorts of problems and technical difficulties along the line. Which is why it’s important you know what the difference between pooling and de-pooling is, and how it works.

What is Pooling?

Pooling for withholding usually means that a QI can use one or more omnibus accounts, into which multiple client assets can be co-mingled. This makes it easier for a counterparty to apply withholding tax without needing to know who the underlying clients are. Pooling for the purposes of reporting is exclusive to QIs, while NQIs can only use pooling to hold assets for the purpose of withholding, but not reporting.

What’s the Point of Pooling?

The benefit of pooling is that, using this method, a QI doesn’t need to create recipient copies of the 1042-S forms for each direct client in the same way that NQIs must. But even for a QI, there are certain kinds of clients that can’t be pooled together with other clients when reporting to the IRS. The main category of client that you can’t pool for reporting is any that gave you a W-8IMY.

For example, if you have 100 clients and 80 of them gave you a W-8BEN or a W-8BEN-E, then you can pool those clients when you report based on the income type and tax rates. Those 80 are reported together, and no individual identities are disclosed to the IRS or anyone else. The remaining 20 gave you a W-8IMY. This means you can’t pool them in any way, and you must report each one to the IRS on a separate 1042-S. They are classed as ‘non-pooled’, so the IRS knows in each case who you paid.

Great, So What’s The Problem?

The above example was a pretty straightforward one, but we all know that things aren’t straightforward in the tax world. So let’s look at another scenario.

You still have 100 clients, but all of them are either direct individuals or entities. Yes, you can pool them for withholding just as before, and you can pool them for reporting too, so the IRS should never find out who your clients are. But if you taxed any of those clients at 30% and they believe they’re due a refund, you run into issues. If you’re not willing or able to use any of the QI refund processes, then the client can, and might, make a formal request to you to receive a recipient copy 1042-S specific to them. The issue is, you’ve already included that client’s income and withholding tax on a pooled report to the IRS. This can also happen if you receive W-8s with treaty claims on them, but you don’t have an adequate validation process, so you end up taxing them at 30% thinking it’s the right rate, when it isn’t.

This leaves you with a problem. According to the QI agreement you signed, section 8.02(P) states that you must satisfy your client’s request for a recipient copy. To do that, you’ll need to take your original filing and extract the gross income and the withholding tax from your pooled report in order to create a recipient copy for your client with just their total amounts. Otherwise known as de-pooling. But once you’ve done that, there’s another issue – your original pooled 1042-S report is now inaccurate, since it was all pooled. So to fix this, you have to file another 1042-S submission and an amended 1042-S to the IRS through their FIRE Portal. This will show the updated pool values (which have been reduced by the amounts making up your recipient copy), plus the de-pooled 1042-S that was generated by your client’s request. The sum of these forms must still match up to the total paid by you by your counterparty/ies. Now that you’ve filed an amended submission to the IRS, you can issue a recipient copy to your client.

That’s Not All…

While all of that is annoying enough, it’s still not the end of the story!

Your client now makes a claim directly to the IRS, using the recipient 1042-S that you created, as evidence of over-withholding. This is easily done with a form 1040-NR for individuals and a form 1120-F for entities. The IRS will pay the claim as long as it can join the dots.

The first dot is your claim that you were over-taxed. The second dot was whether the claimed tax was actually deposited with the US treasury. To figure that out they’ll need to reference the name and EIN of the primary withholding agent from your 1042-S. That’s the firm that physically deposited the tax to the Treasury, which may be your counterparty (although this isn’t common). The problem here is that the primary withholding agent will have co-mingled your deposit amount with others from its other clients, and made payments on dates you aren’t aware of. So the primary agent will often not be able to extract that information from its systems to make a legally binding statement to the US treasury that it deposited your tax – which results in the claim being denied.

The net result is that direct claims to the IRS are rarely successful. But the IRS now knows that one of your clients was likely over-withheld, which would make them question the degree to which you’re meeting your obligations as a QI to withhold at the correct rate and ensure correct deposits are made to the Treasury. They would also expect it to be disclosed in a Periodic Review and your subsequent certification.

As we’ve said many times, over-withholding is as much a material failure/event of default as under-withholding under your QI agreement. So, if you tax at a statutory 30% on a systematic basis because you think it’s easier or less risky – think again! It’s actually more costly and much riskier – after all, the objective of a QI is to tax correctly and not to under or over-withhold. If you have questions about pooled reporting, or want an expert eye to look over your processes, just get in touch with TConsult and one of our team will be happy to help.

If you’re a QI, don’t forget there’s a trade association for you that’s free to join. The Association of Qualified and Authorised Intermediaries has 78 members in 29 countries all trying to help each other with compliance issues.