Why is this Topic Important to Wealth Managers? This topic presents a discussion on information reporting regarding nonresident aliens and domestic interest income. Because some wealth managers work with international clients, or a family in which at least one family member like a spouse or child is foreign, it is helpful to discuss the new proposed reporting requirements as issued by the Department of the Treasury. Having a better understanding of the reported information that will end up in the hands of the IRS will hopefully help wealth managers focus on compliance, as well as wealth preservation and growth.
The Internal Revenue Service recently released new proposed regulations regarding reporting interest payments made to nonresident aliens. A nonresident alien is an individual who is neither a citizen of the United States nor a resident of the United States. We will discuss in a later blogticle this week about how to determine if someone is either a US taxpayer or instead is a non-resident alien (not a US taxpayer).
The new proposed rules require the payor to make an information return on Form 1042-S, “Foreign Person’s U.S. Source Income Subject to Withholding” on interest payments aggregating $10 or more each year paid to a nonresident alien, that is otherwise reportable on a Form 1099 (interest income). 
The payor shall generally prepare and file Form 1042-S at the time and in the manner prescribed by the code and the regulations, for the calendar year in which the interest is paid. 
The IRS and Treasury Department first published, in 2001, a notice of proposed rulemaking which provided that U.S. bank deposit interest paid to any nonresident alien individual must be reported annually to the IRS.  Then in 2002, the Treasury Department and the IRS withdrew these regulations and proposed narrower regulations that would require reporting only on interest payments to nonresident alien individuals that are residents of certain designated countries or, at the option of the payor, on interest payments to all nonresident alien recipients of bank deposit interest. 
Under regulations currently in effect, reporting of U.S. bank deposit interest is required only if the interest is paid to a U.S. person or a nonresident alien individual who is a resident of Canada. 
The newest proposed regulations published this month withdraw previous regulations and provide proposed regulations that extend the information reporting requirement to include bank deposit interest paid to nonresident alien individuals who are residents of any foreign country.
The Treasury Department notes 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.
Second, requiring routine reporting to the IRS of all U.S. bank deposit interest paid to any nonresident alien individual is aimed to further strengthen the United States exchange of information program, consistent with adequate provisions for reciprocity, usability, and confidentiality in respect of this information.
Finally, the proposed regulations are designed to 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).
Who is concerned with the proposed enactment of these new rules? The US financial services community including wealth management firms that have interest bearing assets of foreigners. Briefly, US financial firms think that foreigners will move their assets out of the US into other countries such as the City of London, Switzerland, Hong Kong, and Singapore) that do not have such reporting rules. Historically, when countries have increased tax on interest, in general money does flee to other countries. We will also cover this capital flight issue in a historical context in later blogs to provide a wealth manager a better understanding of the likely economic impact to their clients and the US economy should the new interest reporting rules inevitably be enacted.
Tomorrow’s blogticle will discuss important planning aspects of 2011.
We invite your opinions and comments by posting them below, or by calling the Panel of Experts
IRC Section 7701(b)(1)(B).
 Internal Revenue Bulletin: 2011-8; REG-146097-09.
 For rules regarding the preparation of a Form 1042 see Treasury Regulations §1.1461-1(b); for rules for furnishing a copy of the Form 1042-S to the payee see Treasury Regulations §1.6049-6(e)(4).
 REG-126100-00, 2001-1 C.B. 862.
 See Treasury Regulations § 1.6049-4(b)(5).