As published in the Daily Business Review on October 16, 2012.
U.S. financial institutions are currently only required to report bank deposit interest earned by residents of Canada to the IRS. But beginning next year, U.S. financial institutions will be required to annually report the bank deposit interest earned by non-U.S. residents to the IRS. These rules will apply to interest totaling $10 or more.
What is most notable — and troublesome to investors — about the issuance of these regulations is the recent confirmation that the IRS may share this information with the account holders’ home countries.
This raises privacy concerns for non-U.S. residents.
In response to the concerns raised by these new regulations — and the fear of some depositors moving their money to places such as Panama or the Cayman Islands, countries with stronger privacy laws — the Florida International Bankers Association recently reported that it has been educating its members on what these rules are really intended for: to combat tax evasion.
The IRS says that these regulations are essential to the government’s efforts to combat offshore tax evasion for several reasons.
First, they allow the IRS to, in appropriate circumstances, exchange information relating to tax enforcement with other countries. To ensure that U.S. taxpayers cannot evade U.S. tax by hiding income and assets offshore, the IRS must be able to collect information from other countries regarding income earned and assets held in those countries.
Second, in 2010, Congress supplemented the already established network of information exchange agreements by enacting the Foreign Account Tax Compliance Act, which requires overseas financial institutions to identify U.S. accounts and report information, including interest payments, about those accounts to the IRS. In many cases, however, the implementation of FATCA will require the cooperation of foreign governments in order to overcome legal impediments to reporting by their resident financial institutions.
Like the United States, these foreign governments are keenly interested in addressing offshore tax evasion by their own residents and need tax information from other countries, including the United States, to support their efforts. These regulations will facilitate cooperation by better enabling the IRS, in appropriate circumstances, to reciprocate by exchanging information.
Finally, the information gathered will make it more difficult for U.S. taxpayers with U.S. deposits to falsely claim to be nonresidents to avoid paying taxes on their deposit interest income.
In an attempt to allay fears, the Treasury Department has emphasized that the regulations do not force the United States to share information.
On Sept. 11, Timothy Geithner, the Secretary of the Treasury Department, responded to a letter written by Florida Congresswoman Debbie Wasserman Schultz regarding the consequences these new regulations may have on Venezuelan residents holding accounts at U.S. financial institutions.
According to the Treasury Department, the IRS will not share the collected information with Venezuela because, in its view, Venezuela does not have “sufficient safeguards in place to ensure the proper use of the information and to protect its confidentiality.”
This response is not all that surprising even though the IRS recently released (in revenue procedure 2012-24) a list of all the countries — which included Venezuela — that have an income tax or other convention or bilateral agreement relating to the exchange of tax information. Under these agreements, the United States agrees to provide, as well as receive, information.
But the preamble to the final regulations specifically indicates that, even when such an agreement exists, the IRS is not compelled to exchange information, including information collected pursuant to the regulations, if there is concern regarding the use of the information or other factors exist that would make exchange inappropriate.
The question is whether non-U.S. residents, concerned about their privacy, can protect their assets but still remain in compliance with these new regulations. And, at the same time, how to prevent the flight of capital, which would put U.S. banks at a competitive disadvantage.
One possible solution may be for the non-U.S. resident to simply own his or U.S. bank accounts through an entity, such as a partnership or a non-grantor trust, as opposed to owning the account directly in his or her individual name. The regulation only requires reporting for U.S. source interest paid to non-resident alien “individuals.”
But it is not entirely clear whether certain entities would be appropriate for this purpose, such as a single-member limited liability company or a grantor trust.
Typically, those entities are disregarded for U.S. federal tax purposes, resulting in the owner or grantor, respectfully, being treated as the owner of the underlying assets. In some cases, however, the IRS has treated those entities as separate entities for federal tax purposes.
For example, in one ruling, the IRS indicated that state law controls when determining the nature of a person’s interest in property. The IRS concluded that a partnership checking account is an asset and property of the partnership — not of the individual partner even though the business entity is disregarded as an entity separate from the taxpayer for federal tax purposes.”
While this ruling contains some favorable language, it is not yet clear whether it could be relied on by a non-U.S. taxpayer to avoid these new information reporting requirements.
This article was authored by my good friend Jeffrey L. Rubinger is a domestic and international tax partner at Bilzin Sumberg Baena Price & Axelrod.