The U.S. has had a longstanding policy of not taxing deposit interest of nonresident aliens to encourage foreign investment in U.S. financial institutions.
And except for nonresident aliens from Canada, you weren’t required to report this deposit interest to the IRS. The Foreign Account Tax Compliance Act (FATCA) of 2010 changed all that.
The U.S. government wants to identify potential U.S. taxpayers who evade tax by hiding income and assets offshore. FATCA requires overseas financial institutions to identify U.S. accounts and report them the IRS.
To expect such cooperation from foreign governments, the IRS and the Treasury believe they’ll need to have similar information available to trade with those foreign governments that also are interested in detecting offshore tax evasion by their residents.
So the IRS issued a regulation last spring requiring financial institutions to report interest payments made to nonresident aliens.
This rule goes into effect Jan. 1, 2013 (with reporting to the IRS by March 15, 2014).
Under the rule, deposit interest still won’t be taxed, but credit unions must report any interest aggregating $10 or more paid to certain nonresident aliens on IRS Form 1042-S (Foreign Person’s U.S. Source Income Subject to Withholding).
Previously, credit unions were only required to file Form 1042-S for Canadian residents. The new rule extends this requirement to all nonresident aliens from countries that have an exchange agreement with the U.S. Currently 78 jurisdictions have this type of information exchange agreement. (The list of these jurisdictions is available in the IRS Revenue Procedure 2012-24.)
Credit unions also must provide a copy of the completed form to the nonresident alien member and must inform the member that the credit union has filed the form with the IRS.
NEXT: Opposition to the rule