The IRS seems to be putting the infamous FATCA statute into effect two years early. It's already withholding 30% of all U.S. income generated from U.S. securities accounts owned by non-resident aliens (NRA). That's only supposed to begin happening in two years.
FATCA, enacted in 2010, imposes a 30% withholding tax on many types of U.S-source income and gross sales proceeds payable to non-resident alien (NRA) investors, foreign financial institutions (FFIs) and non-financial foreign entities (NFFEs). FATCA's 30% levy also overrules provisions in U.S. tax treaties that otherwise eliminate or reduce withholding.
In some cases, including interest from U.S. Treasury bonds and capital gains in securities portfolios, this income would otherwise not be subject to tax.
FFIs and NFFEs have two choices to avoid this tax:
- They can stop doing business with any U.S. citizen or tax-resident alien; or
- They can serve as unpaid IRS informants through a complex compliance scheme that often violates privacy laws in their own jurisdiction.
You can probably guess what option FFIs and NFFEs are choosing. Most of them are firing their U.S. clients.
Withholding under FACTA doesn't start until Jan. 1, 2014 and will come fully into effect over three years. However, I've now learned that the IRS collections division is already withholding all income from a securities account owned by a NRA at 30%, including capital gains. The NRA lives in a country with a U.S. tax treaty, so he should be able to use it to reduce or eliminate withholding taxes. But, the IRS refuses to let the NRA apply the tax treaty. This is despite the fact that the IRS international help desk tells the NRA's advisers that no tax should be withheld.
The NRA may be forced to sue the IRS to get back the tax that should never have been withheld. Did the collections division make a calculated decision to withhold the tax because it thought the NRA would back down due to the cost of litigation? Or is the withholding some sort of trial run for FATCA?
I don't know the answer, but effectively immediately, I'm advising all NRA clients who hold U.S. securities accounts to assume all income from these accounts—including capital gains—will be subject to a 30% withholding tax. I'm also advising them that they might not be able to get the tax refunded, even if they live in a country with a tax treaty with the United States.
Are you a non-resident alien investor in U.S. securities markets, or for that matter, U.S. real estate? Have you had supposedly non-taxable income withheld at 30%, and not been able to obtain a refund? On what grounds was the tax withheld? Post your comments, please.
Copyright © 2012 by Mark Nestmann
