Reporting by Foreign Entities on Financial Accounts of U.S. Persons
In 2010, Congress enacted a series of international tax laws designed to require foreign financial institutions (FFI) and other nonfinancial foreign entities (NFFEs) to provide information about accounts and interests held by U.S. persons. These regulations generally apply to payments made after 2010 (1).
The Withholding Rules for Foreign Entities
Under the rules passed by Congress, payors must withhold tax at 30 percent from most payments made to foreign entities by U.S. sources. The payments subject to the withholding rule include interest, dividends, and royalties. It also applies to items that might not normally be subject to U.S. tax, such as portfolio interest and capital gains of foreign interest.
This rule essentially means that a foreign entity holds U.S. investments, it must provide information to the IRS about its U.S. clients, or else pay a 30 percent withholding tax on those U.S. investments. If an FFI wishes to escape the withholding requirement, it may do so only by entering into an agreement with the IRS under which it reports to the IRS information about accounts of U.S. persons. NFFEs can avoid paying the withholding tax by providing information to U.S. withholding agents about U.S. persons involved with the NFFE.
What Agreements Can FFIs Enter Into with the IRS?
Some FFIs enter into agreements with the IRS to avoid to lessen the effects of the withholding rules. As stated above, FFIs can agree to turn over information to the IRS about its U.S. investors, it will not be subject to the withholding rules. Also, FFIs can agree to become qualified intermediaries (QIs), which requires the foreign entity to collect documentation from its clients sufficient to establish the clients’ status for the purposes of withholding under IRC sections 1441 and 1442. Under IRC §§ 1441 and 1442, persons and entities that make payments to foreign persons are required to withhold tax from items that come from U.S. sources, including dividends, interest, royalties, and other forms of fixed annual or periodic income (2). Under the QI agreement with the IRS, the FFI can also choose to withhold U.S. income tax on these items.
The Role of Withholding Agents
Under the rules governing the reporting obligations of foreign entities with financial accounts of U.S. person, a “withholding agent” paying U.S. source interest, dividends, rents, royalties or making a “withholdable payment” in any other form to a “foreign financial institution” (FFI) must withhold tax equal to 30 percent of the amount paid unless the FFI has made an agreement with the IRS. The terms “withholdable payment” and “withholding agent” have particular and specific definitions in the context of the statute.
Withholding Payments as Defined Under the Reporting Rules
The term “withholding payments” is defined to generally include all payments of interest, dividends, rents, salaries, wages, and other “fixed or determinable annual or periodical gains, profits, and income,” where the source of those payments is within the United States. Withholding payments also includes gross proceeds of sales and other dispositions of “property of a type which can produce interest or dividends from sources within the United States.” A payment is not considered withholdable under the statute if the beneficial owner of the payment is taxed on the amount as income connected with a U.S. trade or business.
Withholding Agent as Defined Under the Reporting Rules
Under the regulations, a “withholding agent” is a person, “in whatever capacity acting, having the control, receipt, custody, disposal, or payment of any withholdable payment.” For these purposes, the withholding agent usually refers to a U.S. financial institution, or the person that makes the payments to an FFI or NFFE. Withholding agents are subject to personal liability for the amounts required to be withheld under the rules, but have the possibility of indemnification “against the claims and demands of any person for the amount of any payments made in accordance with” these rules. Thus, the withholding agent is responsible for deciding what amounts are required to be withheld under the rules and may also be responsible for any mistakes it makes in executing this responsibility.
Credits and Refunds Available Under the Reporting Rules
If a beneficial owner overpays under the withholding rules, that beneficial owner can obtain a refund or credit from the IRS. However, if the beneficial owner is an entity as opposed to an individual, no credit or refund is available unless the beneficial owner provides the IRS with certain information, which would allow the IRS to establish that the entity is a U.S.-owned foreign entity.
How a Tax Attorney Can Help
The Tax Lawyer - William D. Hartsock has been successfully helping clients with tax issues related to their foreign assets since the early 1980s. Mr. Hartsock offers free consultations with the full benefit and protections of attorney client privilege to help people clearly understand their situation and options based on the circumstances of their case. To schedule your free consultation simply fill out the contact form found on this page, or call (858) 481-4844.
Tax Law References:
- Pub. L. No. 111-147, § 501, 124 Stat. 71 (2010).
- IRC §§ 1441 and 1442.