The IRS recently issued final regulations expanding the information reporting requirements for deposit interest paid by certain U.S. financial institutions to nonresident aliens. Under the new rules, U.S. financial institutions, including banks, credit unions, savings institutions, securities brokerages, and insurance companies, are required to report interest paid to nonresidents who are residents in countries with which the U.S. has an information exchange agreement in effect.
These new reporting rules have no effect on the U.S. income taxation of interest income earned by nonresidents. To reiterate, nonresidents continue to be tax exempt on deposit income, these new rules simply require reporting to the IRS of the deposit interest.
Under the regulations currently in effect, this information reporting is required only for interest payments made to U.S. persons or nonresidents who are residents of Canada. However, the IRS concluded that requiring the additional reporting would strengthen the information exchange program and increase voluntary compliance with U.S. tax rules. The information exchange program is especially important given the upcoming implementation of FATCA (“Foreign Account Tax Compliance Act”) regulations which will require non-U.S. financial institutions to report similar information to the IRS on accounts held abroad by U.S. persons. The IRS needs to be able to reciprocate tax information reporting if the information exchange program is to succeed. The new regulations also make it more difficult for U.S. persons to falsely claim nonresident status in order to avoid U.S. taxation of their interest income.
The new rules apply to payments of interest made on or after January 1, 2013, and reporting will be required for any year in which the U.S. financial institution makes payments to the nonresident depositor totaling $10 or more. Reporting will take place on Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding.” Despite the name of the form, it is important to note again that the new regulations only expand the reporting requirements of U.S. financial institutions. While many nonresident aliens with U.S. bank deposits will be receiving Forms 1042-S for the first time (in 2014, reporting interest payments made in 2013), the interest income they earn will still not be subject to U.S. income tax.
The financial institution is only required to make the report if the individual is a resident of a country (as of the end of the previous year) with which the U.S. has an information exchange agreement in place, but the financial institution may elect to report interest payments to all nonresident aliens. The payor may rely on the permanent residence address provided by the individual on a valid Form W-8BEN, “Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding,” to determine the individual’s country of residence, unless the payor has reason to believe that this information is unreliable or incorrect.
The information collected will not necessarily be reported to the foreign jurisdiction under the information exchange agreements. There are more than 70 such agreements currently in effect, and automatic reporting currently applies only to Canadian residents. Additional countries will be added to this list only after further assessment of the country’s confidentiality laws and practices and the extent to which that country is willing and able to reciprocate with the U.S.
If you have any questions about this article, please contact Grant Miller at firstname.lastname@example.org.
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