United States tax: Potentially significant liability for noncompliance with information reporting and withholding obligations

The U.S. Internal Revenue Service (IRS) has recently increased its enforcement of offshore financial account compliance and placed an emphasis on information reporting and withholding as a means of closing the U.S. tax gap. Although most prevalent with financial institutions, this increased scrutiny applies broadly. One element of the IRS's execution strategy is the designation of this area as a "Tier I" issue. Tier I issue status results in increased IRS audit activity for the designated area. While the tax compliance risk has substantially increased and could have a material impact on the company's financial statements, many companies may not be aware that they are subject to these requirements and it is not uncommon for companies to be off in their estimates by 30% to 70% of the ultimate liability.

Generally, a foreign person (nonresident alien, foreign partnership, foreign corporation, foreign estate and foreign trust) is subject to U.S. tax on what is referred to as its "U.S.-source income." U.S.-source income includes items such as dividends, interest, royalties, rents or personal service receipts paid by domestic corporations, U.S. citizens or resident aliens or entities formed under the laws of the U.S. or a state. U.S. companies that make these types of payments are deemed to be "withholding agents" and are responsible for withholding estimated U.S. tax on the payments and for properly reporting this withholding on the required forms. Failure to comply can result in penalties and interest to the withholding agents. To determine whether exposure exists and to quantify the exposure, affected foreign persons should evaluate current processes, including assessing the accuracy of the data, completing the necessary reporting and calculating the appropriate withholding.