Form 1042-S Exemption Code 04: Treaty Claims, W-8 Proof, and Errors

Exemption code 04 on Form 1042-S means the payment of U.S.-source income to a foreign person was exempt from withholding, or taxed at a reduced rate, because of an income tax treaty between the United States and the recipient’s country of residence.¹ Without an exemption, Chapter 3 of the Internal Revenue Code imposes a flat 30% tax on this income.² Code 04, entered in Box 3a, tells the IRS that a treaty is the reason a lower rate (or no withholding at all) was applied.

The rate that replaces the 30% default depends on the specific treaty and the type of income. Some treaties reduce the withholding rate on dividends to 15% or 5%; others eliminate withholding on royalties entirely. Code 04 covers the full span, from a modest rate cut to complete exemption. Common income types where treaties reduce or eliminate withholding include interest, dividends, royalties, and certain personal service income.³ When Code 04 is used, the country code in Box 13b must correspond to a country that actually has an income tax treaty with the United States.¹

When Code 04 Is Wrong and Code 02 Is Right

One of the most frequent mistakes on Form 1042-S is using Code 04 when Code 02 is correct. Code 02 means “exempt or reduced withholding under IRC,” covering situations where the Internal Revenue Code itself provides the exemption rather than a treaty. The portfolio interest exemption is the classic example. Under IRC Section 871(h), interest on certain registered obligations paid to a foreign person who is not a 10-percent shareholder is exempt from the 30% withholding tax without any treaty involvement.⁴

The distinction matters because Code 04 requires a valid treaty country in Box 13b. Using Code 04 for a portfolio interest payment where the exemption actually comes from the IRC creates a mismatch that can trigger IRS inquiries. The rule: if the exemption flows from a treaty, use Code 04. If it flows from a provision of the Internal Revenue Code, use Code 02.¹

What to Do If You Received a 1042-S With Code 04

If you are the foreign recipient, the form is telling you that treaty benefits were applied to your U.S.-source income. In many cases, you will not need to file a U.S. tax return. A nonresident alien who was not engaged in a U.S. trade or business during the year and whose U.S. tax was fully covered by withholding, or fully exempt under a treaty, generally does not need to file Form 1040-NR.⁵

There are situations where filing still makes sense. If the withholding agent withheld more than the treaty rate required, you may be owed a refund, and you would need to file Form 1040-NR to claim it. If the treaty reduced the rate but did not eliminate it, check that Box 7 on your 1042-S matches the correct treaty rate applied to your gross income. Errors on 1042-S forms are not uncommon, and catching them early is far easier than correcting them after the filing deadline.

Documentation Required Before Code 04 Can Be Used

Before a withholding agent can apply Code 04, the foreign recipient must certify their eligibility for treaty benefits. That certification comes on the appropriate Form W-8, submitted to the withholding agent before the payment is made.

Nonresident alien individuals use Form W-8BEN. The form declares foreign status and identifies the specific treaty article that supports the reduced rate or exemption.⁶
Foreign corporations, partnerships, and other entities use Form W-8BEN-E. Part III of that form is designated for treaty benefit claims.⁷

Treaty claims generally require the recipient to provide a U.S. taxpayer identification number (an SSN or ITIN) on the W-8. Without a valid Form W-8 that meets the due diligence rules, the agent must apply the default 30% rate. It cannot reduce the rate for treaty benefits even if it “knows” the recipient qualifies.⁸

A Form W-8BEN submitted without a U.S. TIN expires on the last day of the third calendar year after it was signed. Submitted with a U.S. TIN, it remains valid indefinitely unless the recipient’s circumstances change in a way that makes information on the form incorrect.⁹

Reliability of the W-8

Collecting a signed Form W-8 is necessary but not sufficient. The withholding agent must determine that the documentation is reliable before applying any reduced rate. Under IRS Publication 515, a withholding certificate is unreliable if it is incomplete, contains inconsistent information, lacks details needed to support a reduced rate, or conflicts with other information the agent has on file.¹⁰ A treaty claim needs a second look if the recipient’s mailing address is in a country different from the treaty country listed on the W-8, or if the recipient claims benefits under a treaty that does not cover the type of income being paid. If the agent fails to withhold and cannot show due diligence, it can be held personally liable for the unpaid tax, plus penalties and interest.²

Where Code 04 Sits on the Form

The form’s layout is dense, and the treaty exemption touches several boxes at once.

Box 1 (Income Code) identifies the type of income. Interest on deposits uses Code 29, original issue discount uses Code 30, general dividends from U.S. corporations use Code 06, and industrial royalties use Code 10.¹¹
Box 2 (Gross Income) shows the full payment, regardless of whether any tax was withheld.
Box 3a (Exemption Code) is where “04” goes. This is the chapter 3 exemption code field.
Box 3b (Tax Rate) shows the treaty rate. Full exemption reads 00.00; a 15% treaty rate reads 15.00.
Box 7 (Federal Tax Withheld) is the actual dollar amount withheld. When a treaty fully exempts the income, this is zero.
Box 13b (Country Code) must show a country that has an income tax treaty with the United States. A non-treaty country here with Code 04 in Box 3a is an error.

Form 1042-S also requires a chapter 4 (FATCA) exemption code in Box 4a and a rate in Box 4b. These are separate from the chapter 3 fields, and both must be completed correctly on every form.¹

Deadlines and Penalties for Getting It Wrong

Form 1042-S must be filed with the IRS and furnished to the income recipient by March 15 of the year following the calendar year of payment. When March 15 falls on a weekend or legal holiday, the deadline moves to the next business day.¹² Withholding agents that file 10 or more information returns during a calendar year must file electronically.¹³

Getting Code 04 wrong, whether by using it when Code 02 applies, entering the wrong treaty rate, or filing late, carries real financial consequences. For returns due in 2026, the penalty tiers for filing incorrect or late Forms 1042-S are:

Corrected within 30 days: $60 per form, maximum $698,500 per year ($244,500 for small businesses with average annual gross receipts of $5 million or less).
Corrected after 30 days but by August 1: $130 per form, maximum $2,095,500 ($698,500 for small businesses).
Filed after August 1 or not filed at all: $340 per form, maximum $4,191,500 ($1,397,000 for small businesses).
Intentional disregard: the greater of $690 per form or 10% of the total amount required to be reported, with no maximum cap.

The same penalty structure applies to failures to furnish correct Forms 1042-S to recipients.¹² These penalties are separate from liability for the underlying tax. A withholding agent that incorrectly applies Code 04 and withholds nothing when 30% should have been withheld can owe both the unwithheld tax and the reporting penalties.

1
Internal Revenue Service. Instructions for Form 1042-S
2
Internal Revenue Service. Tax Withholding Types
3
Internal Revenue Service. Claiming Tax Treaty Benefits
4
Office of the Law Revision Counsel. 26 US Code 871 – Tax on Nonresident Alien Individuals
5
Internal Revenue Service. Instructions for Form 1040-NR
6
Internal Revenue Service. About Form W-8 BEN
7
Internal Revenue Service. Form W-8BEN-E
8
Internal Revenue Service. Instructions for the Requester of Forms W-8BEN, W-8BEN-E, W-8ECI, W-8EXP, and W-8IMY
9
Internal Revenue Service. Instructions for Form W-8BEN
10
Internal Revenue Service. Publication 515 (2026), Withholding of Tax on Nonresident Aliens and Foreign Entities
11
Internal Revenue Service. Form 1042-S
12
Internal Revenue Service. Instructions for Form 1042-S (2026)
13
Internal Revenue Service. Electronic Reporting of Form 1042-S