February 14, 2011 –
New Rules on Interest Reporting for Nonresident Aliens Proposed

Earlier today (January 6, 2011), the Internal Revenue Service issued new proposed regulations which, if finalized, will require annual reporting of interest paid on deposits maintained by nonresident aliens at U.S. offices of certain financial institutions.  These new proposed regulations replace ones that were issued in August 2002 (the “2002 Proposed Regs”), which themselves replaced 2001 proposed regulations (the “2001 Proposed Regs”).

The 2001 Regulations were severely criticised for their requirement that deposit interest paid to any nonresident alien individual must be reported annually to the IRS.  As a result of that criticism, the 2002 Regulations limited the reporting requirements only on interest payments to nonresident alien individuals that are residents of certain designated countries (which, so far, means only residents of Canada) or, at the option of the payor, on interest payments to all nonresident alien recipients of bank deposit interest.  The new regulations return to the 2001 proposal that all interest be reported.

In explaining why the IRS is once again proposing that all interest paid to nonresident aliens be reported, the Notice states:

This extension is appropriate for several reasons. First, since the 2002 proposed regulations were released, there is a growing global consensus regarding the importance of cooperative information exchange for tax purposes that has developed. Significant agreements have been reached on international standards for the exchange of information, including, for example, the understanding that information exchange will not be limited by bank secrecy or the absence of a domestic tax interest. Second, requiring routine reporting to the IRS of all U.S. bank deposit interest paid to any nonresident alien individual will further strengthen the United States exchange of information program, consistent with adequate provisions for reciprocity, usability, and confidentiality in respect of this information. Finally, this extension will help to improve voluntary compliance by U.S. taxpayers by making it more difficult to avoid the U.S. information reporting system (such as through false claims of foreign status).

If the Regulations are finalized, the new reporting rules will also require that a copy of the Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding”, will need to be sent to the nonresident alien “either in person or by first class mail to the recipient’s last known address.”

To read a copy of the proposed regulations (REG-146097-09), click here.