Published: September 2, 2022

If you have ever received a mystery IRS refund check where the memo field says “945” or “1042”, read on. You likely have one of these dangers lurking in your annual filings. These issues can take years to appear which means you likely have a multi-year forensic analysis to undertake.

Issue 1: Duplicate filings

The IRS can only accept one Form 945 filing per EIN and one Form 1042 per payer EIN. The two most common examples of duplicate filings that I see include:

A clerk wants to split divisions out and files two Forms under the same EIN but with two different names like “Company Inc - Division A” and “Company Inc - Branch B”.
A payer uses a managed service provider to file 95% of their customer payments Forms 1099 or 1042-S to the IRS. That managed service provider offers to file Forms 945 and 1042 on behalf of the payer for those customer payments. But the payer has a separate batch of vendor payments Forms 1099 or 1042-S that they file on their own or with another software company. So the managed service provider files the first Form 945 or Form 1042 reporting $100,000 of tax liability and then the payer files a second one to report the separate batch with a $50,000 tax liability.

When the IRS receives multiple filings of a Form 945 or Form 1042, they simply throw away the second one. It is never processed and they won’t send you a letter to let you know. It may show up on a transcript record as “Filing - duplicate” but with no capture of the tax liability reported. They then process $150,000 tax deposits made against the tax liability reported on the first filing of $100,000, and issue a refund check for the difference of $50,000. As this $50,000 does not belong to the payer, they may now start accumulating late depositing penalties for holding onto the funds.

Issue 2: Incorrect reporting of liabilities over December 31

Forms 945 and 1042 tax liability totals must match exactly to the aggregate Forms 1099 and 1042-S submitted to the IRS (generally electronically through the IRS FIRE system). However, it can take the IRS 3+ years to process the Forms 1099 and 1042-S and issue a tax due or refund notice to a payer where the totals do not match the Forms 945 or 1042 that were filed 3+ years earlier. A common reason that the totals do not match is for large payers who are daily tax depositors and settling sales of equities (as example). Due to the SEC T+2 settlement rules, payers can mistakenly report the tax liability on Forms 945 or 1042 according to the settlement date rather than the transaction date (1-2 days earlier). The result is that a transaction with backup withholding could be reported on a 2022 Form 1099 but the tax liability reported on a 2023 Form 945.

Issue 3: Not reconciling to IRS Transcripts before filing

Both Forms 945 and 1042 have a line for the payer to report the total tax deposits made during the reporting period in order to calculate the tax due or refund position. This is commonly populated according to the accounting records of the payer. But many payers fail to download IRS transcripts to reconcile that both records agree to eachother prior to filing. Without a reconciliation to IRS records, the payer may receive an unexpected tax refund or notice of tax due from the IRS. This can occur where the IRS moves tax payments between filing records. For example, if the IRS detects there is a tax overpayment in the corporate 1120 filing of the payer, then they may transfer it into accounts that have a tax due balance (like Form 945 or 1042) thereby creating an unexpected overpayment in the Forms 945 or 1042 filing and a missing refund check in the 1120 filing. This can create further accounting and fund segregation headaches when the Forms 945 or 1042 tax deposits are related to customers of the payer while the 1120 tax deposits are corporate taxes of the payer itself.

Bonus Issue: Not filing nil (zero) returns

IRS statute of limitations begin at the later of 1) the date a return is due, or 2) the date a return is filed. If you never file a Form 945 or Form 1042 then the statute remains open forever. This trap is not obvious given that a Form 945 is not required to be filed if there was no backup withholding reported on Forms 1099, and Form 1042 is not required if no payments were reportable on Forms 1042-S. In years that a payer has no backup withholding and/or no Form 1042-S reportable payments, a nil/zero Form 945 and/or Form 1042 should be filed in order to start the clock on the statute of limitations.

You’ve identified an issue, now what?

If you suspect any of the above issues are present in your organization, then there could be a multi-year unwinding that must be analyzed and executed very carefully. It is important to address these issues as the IRS can hold the “responsible person” personally liable for any withholding taxes that were not deposited to the IRS under the trust fund recovery penalty. Assessment of this penalty could apply to taxes that were incorrectly refunded due to misfilings of Form 945 or 1042. Not correcting the issues could be viewed as reckless disregard of an obvious risk. Even if you have outsourced filings to a managed service provider, the IRS still views the payer as liable for the taxes.

A few key points to consider:

If you have received an unexpected refund check from the IRS, you could try to deposit it again to the IRS. However, unless the underlying issue has been fixed/amended then they will just process another refund check back to you further delaying the resolution. Consider holding onto the refund check until you have fully identified what it is related to and have the resolution in process.
Establish an IRS e-Services account and start ordering IRS transcripts for all periods and forms. Setting up an account for Transcript Delivery Services can be onerous and may require fingerprinting of an officer. Tie out the transcripts line by line. If you are short on time, you can engage a CPA or lawyer that already has an e-Services TDS account to request transcripts on your behalf by preparing and filing a Form 2848 Power of Attorney.
Don’t go it alone. Consider hiring an advisor that is experienced in unwinding these issues. You may need to amend prior year returns in order to combine duplicate filings, assess how many years to amend, and prepare penalty abatement or waiver requests to the IRS for late tax deposit penalties. Since the IRS sent you a refund check for the taxes they thought you didn’t owe them, then once they process an amended Form 945 or Form 1042 then their systems will view the tax deposits as late even though you originally paid them on time. If many years have passed, then the accrued interest could be huge.

How can Dune Consultants help?

We can help you in all aspects of health checks and advise your organisation in all of the topics discussed here. Contact us today to discuss at info@duneconsultants.com. Or you can jump in the calendar for an introduction call.

Dangers that could be lurking in your Form 945 and 1042 filings