REGULATION IN BRIEF:
Bank Deposit Interest Reporting Requirements
(More Resources)
February 03, 2004 No. 8
Background: On January 17, 2001, three days before Bill Clinton left office, the Internal Revenue Service proposed a regulation to require U.S. banks to report the deposit interest they pay to all nonresident aliens (foreigners who live outside the U.S.). In an effort to mollify critics, this regulation was subsequently modified in 2002 to require reporting of interest paid to nonresident aliens from 15 specific nations (though the IRS explicitly signaled that it quickly would extend the regulation to cover interest paid to all depositors).
There were public comment periods and public hearings for both versions of the regulation. More than 99 percent of the public comments were opposed to the regulation and 100 percent of witnesses at both hearings were opposed to the regulation.
Status: The regulation currently is in limbo. Acting largely at the behest of holdovers from when Paul O’Neill was Secretary, the Treasury Department supports the regulation. The proposal has been blocked, however, because of strong opposition from members of the House and Senate, the White House, public policy organizations, and the financial services industry.
Discussion: For all intents and purposes, this proposal seeks to put foreign tax law above U.S. tax law. For more than 80 years, Congress has deliberately sought to attract this capital to the U.S. economy by choosing not to tax this income and choosing not to require that it be reported. The proposed regulation subverts this law in order to help foreign governments track – and tax – flight capital.
The proposed regulation has been criticized on many fronts. The financial services industry objects to a needless regulatory burden since the regulation is not needed to enforce U.S. law. Banks also warn that the proposed rule will drive deposits to competing institutions in other nations. Many members of Congress are perturbed that the IRS is trying to contravene current law, but they seem even more concerned about the loss of capital to the U.S. economy. Foreign investors have placed about $2.3 trillion in American financial institutions. The IRS regulation only applies to a slice of those funds, but lawmakers correctly argue that it is foolish to drive investment dollars to other jurisdictions. Public policy organizations, meanwhile, warn that the regulation is based on tax policy principles – double taxation of capital and extra-territorial taxation – that are fundamentally inconsistent with President Bush’s tax reform agenda. Last but not least, there is even concern that the proposed regulation will undermine the fight against money laundering by driving money from American banks (where it can be easily monitored and investigated) to foreign institutions that may or may not wish to cooperate with U.S. law enforcement authorities.
Action item: The IRS’s proposed rule should be immediately withdrawn.
This brief was prepared by Heritage Senior Research Fellow Daniel J. Mitchell.
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