CUNA Comment Letter

Proposed Regulatory Changes on Reporting of Deposit Interest Paid to Nonresident Aliens

November 14, 2002

Internal Revenue Service
CC: DOM:ITA:RU (REG-133254-02)
Room 5226
POB 7604
Ben Franklin Station
Washington, DC 20044

RE: Proposed Regulatory Changes on Reporting of Deposit Interest Paid to Nonresident Aliens

Dear Commissioner Rossotti:

On behalf of the Credit Union National Association, thank you for the opportunity to submit our comments on the proposed changes to the Internal Revenue Service’s regulations on the reporting requirements for interest on deposits maintained at the U.S. offices of financial institutions and paid to certain nonresident alien individuals. CUNA represents more than 90% of our nation’s 10,113 state and federal credit unions. Approximately 83 million consumers belong to credit unions.

Summary of CUNA’s Views

CUNA continues to oppose the IRS’ efforts to expand reporting requirements for interest paid to nonresident aliens for the following reasons:

CUNA’s Comments on the Proposal

Changes in the New Proposal

CUNA would like to acknowledge that, consistent with comments contained in our letter to the IRS and in our oral statement during the IRS’ hearing on the former proposal, the new proposed rule includes some changes to address operational concerns.

The earlier proposal would have required reporting of interest paid to all nonresident aliens in the United States who are residents of a country with which the United States has an income tax treaty or tax information exchange agreement. Institutions would have been required to keep track of which countries have such an agreement with the U.S. Under the new proposal, the universe of countries involved would be reduced, and a process would be provided to assist institutions in their efforts to maintain a current list of affected countries. However, even though the number of countries is reduced for now, we are concerned that over time the list could grow substantially, with a corresponding increase in the regulatory burden that institutions would bear.

The new proposal would change the treatment of joint accounts provided in the previous proposal, which was cumbersome. Under the previous proposal, reporting would have been required for all joint nonresident alien account holders who are residents of the covered countries. The new proposal attempts to facilitate reporting for joint accounts, but does not go far enough to address areas of concern. The new proposal would allow institutions to report interest for any one of the joint account holders that is a resident of one of the countries identified by the IRS, if all of the joint account holders have provided a valid Form W-8, which certifies their status as a foreign person. If the joint account holder has not provided Form W-8, then there would be a presumption that the interest is being paid to an undocumented U.S. non-exempt recipient and interest on the deposits for the joint account holders would be reportable on Form1099. The proposal would reach this result because it would eliminate the provision in the current regulation that allows payors to rely on actual knowledge of the individual’s address, even if a valid Form W-8 has not been provided.

While we appreciate the IRS’ efforts to review its proposal regarding joint accounts, the new approach would still create problems. As we have indicated previously, credit unions generally report interest income for primary account holders. They often do not have easy access to addresses for joint account holders or have the addresses in a format that is readily retrievable. Because the proposal would still require reporting for joint account holders, even if they were not the primary account holder, we believe the changes necessary to meet the proposed requirements would be very costly. In addition, requiring institutions to establish different treatment, including separate procedures and processing that would encompass the harsh result of backup withholding, for account holders who do not provide a Form W-8 continues to raise operational concerns for institutions, as well as issues of fairness for such account holders. Currently, the IRS does not require this result for Canadian nonresident aliens, and we do not believe the IRS has provided sufficient justification for changing the rule, as it proposes to do in the context of expanding the scope of its regulations on nonresident alien reporting.

CUNA Urges the IRS To Withdraw the Proposal

The issue of changes aside, we continue to strongly oppose the proposal and urge the IRS to withdraw it. Many of the comments below were reflected in our previous letter and testimony.

Credit unions must currently comply with a number of federal tax reporting requirements regarding consumers’ income and financial activities. These include but are not limited to reporting regarding payment of interest and dividends, Individual Retirement Account deductions or contributions, interest on loans secured by real property, student loans, discharge of indebtedness, foreclosures and abandonment of property and others. Credit unions must also comply with IRS requirements for backup withholding and other IRS regulations.

Cumulatively, the burden of compliance with these requirements is substantial, particularly for smaller credit unions. About two-thirds of all credit unions have assets of less than $20 million and nearly one-third are operated by unpaid volunteers. Any new requirement must be evaluated in the context of these current requirements.

In our view, given the considerable compliance responsibilities imposed under IRS rules that financial institutions are already meeting, we believe the IRS should refrain from developing new reporting obligations for financial institutions, unless such requirements are demonstrated to be essential in order to implement a provision in the federal tax code. We do not believe that the IRS has clearly demonstrated the need for the proposal.

We believe the costs associated with compliance under the proposal will be substantial. Based on information from our members, credit unions that are covered by the agency’s requirement to report interest paid to nonresident alien individuals who are residents of Canada generally do so on a manual basis as they have fewer than 250 filings, the threshold for filing by magnetic media. If the IRS extends the information reporting requirements for all nonresident aliens, some covered credit unions may still not have 250 filings but could have a significant number of individuals for whom they must report, making manual procedures much more complicated if not impractical.

Credit unions do not generally have data processing systems that have been programmed to identify nonresident alien individuals’ accounts and prepare IRS Form1042-S. For credit unions that are automated, and many smaller ones are not, new software would have to be purchased, or current systems would have to be substantially altered, at an appreciable cost to the credit union.

In several key ways, credit unions are different from commercial banks and other financial institutions that would be covered by the proposal. Because credit unions are financial cooperatives, the costs of compliance with any regulation, including this new proposal, are borne by the members of the credit union who own it. Thus, the proposal will not only impact credit unions as covered entities, but also their consumer members.

In addition, we are very skeptical about the IRS’ estimate of the average annual burden it anticipates the proposal would impose. The new proposal states that the average annual burden for each respondent would be 15 minutes, with a total annual reporting burden of 500 hours for 2,000 respondents. This is the same estimate the IRS provided for the previous proposal, which was broader in several respects, causing us to doubt both estimates accompanying the former as well as the current proposal.

Also, again the IRS has not provided information as to how it derived these figures, which appear to be very low. We urge the IRS to clarify how it determined these estimates. We also question the IRS’s Special Analyses accompanying the proposal regarding whether the rule is a significant regulatory action, the applicability of the Administrative Procedure Act and the applicability of the Regulatory Flexibility Act. We request that the IRS provide the basis for its determinations on these issues before proceeding with this rulemaking.

Perhaps more important for credit unions and their members than the cost of compliance are the public policy issues raised by the proposal. As indicated above, we do not believe the need for this proposal has been substantiated. Yet, if adopted, it would divert limited credit union resources away from credit union members—credit unions’ primary function is to serve the financial needs of their members—into information reporting activities, which may be of marginal use to the IRS.

Further, we think the IRS should consider the impact of this proposal could have on undocumented persons in this country. If the proposal is adopted, such individuals may be extremely reluctant to use the services of traditional financial institutions and turn instead to unscrupulous vendors, which escape reporting requirements and charge unconscionable fees for financial services. (Also, the proposal may encourage financial institutions to avoid paying interest on accounts to bypass the compliance burdens this proposal will inflict.) At the very least, if the IRS does go forward with the proposal, we urge the agency to provide public assurances that it will not share information obtained through 1042-S reporting with other agencies.

Under the proposal, the rule would take effect for payments after December 31 in the year that the rule is promulgated. If the IRS determines that it must proceed with the new proposal, we urge it to give institutions sufficient time to be notified of these amendments, to arrange for changes to their systems and to implement reprogramming and other operational changes. Financial institutions should have at least a full year after the rule is published before it applies to payments.

For the reasons discussed above, we strongly oppose this proposal and request that the IRS withdraw it on the grounds that the costs to financial institutions and consumers associated with compliance will far outweigh any benefit to the IRS and that the IRS has not demonstrated that the proposal is necessary to implement a statutory provision of the tax code.

Thank you for the opportunity to share our views on this matter.

Sincerely,

Mary Mitchell Dunn
Senior Vice President and Associate General Counsel