The Internal Revenue Service has announced an aggressive withholding tax enforcement initiative targeting financial institutions with operations in the United States. The IRS will eventually conduct several hundred examinations of banks, broker-dealers, and other financial services firms with customers who have claimed foreign status in order to reduce or eliminate U.S. withholding tax on depository interest, dividend distributions, and the proceeds from the sale of securities.

According to the IRS, the examinations will focus on financial institutions that did not participate in the IRS’ Section 1441 Voluntary Compliance Program. That program, which closed last summer, allowed a financial institution to self-assess whether it complied with a complex set of regulations governing the documentation of foreign persons. The participants were able to correct any noted deficiencies and avoid paying U.S. withholding tax and associated penalties that would otherwise have been assessed if the deficiencies had been detected during an IRS examination.

Based on our experience advising clients on these withholding issues, it is evident that the current IRS examination teams are strictly interpreting the governing regulations. We recommend that any financial institution that did not participate in the Section 1441 Voluntary Compliance Program consider a third-party compliance review at this time. A careful analysis of account opening policies and procedures, foreign status recertification requirements and a review of the documentation of non-resident alien and foreign entity accounts could significantly reduce potential exposure. Consultation with an attorney experienced with the intricacies of the IRS withholding examination process is advisable if you are notified that you have been selected for an examination.

This article is designed to give general information on the developments covered, not to serve as legal advice related to specific situations or as a legal opinion. Counsel should be consulted for legal advice.