Tax Analysts Blog

U.S. Bank Secrecy is Alive & Kickin'

Posted on Aug 26, 2009

No doubt you've heard about our government's get-tough policy on tax evasion. It was splashed all over the headlines -- both here and overseas --- in connection with last week's deal between the U.S. Department of Justice and UBS, the influential Swiss bank that claims to be world's largest manager of private wealth.

The settlement involved some delicate negotiations due to the Swiss government's insistence that its bank secrecy rules be respected. As a result, the DOJ's request for names of American tax dodgers is being processed through the Switzerland-U.S. tax treaty. Opinions vary as to who got the better deal: Swiss banks or the IRS.

But that's not our topic for discussion. Today we're talking about U.S. bank secrecy. Lost in the shuffle of emotions over the UBS affair is the fact that America is just as effective as Switzerland at sheltering bank accounts and facilitating tax evasion.

Technically speaking U.S. law does not have a bank secrecy regime, but it offers de facto bank secrecy to nonresident aliens (NRAs) who deposit funds in the U.S. banking system. The interest on those deposits is typically fully taxable in the NRA's home country, but that tax is very rarely paid. That's no accident; it's a carefully orchestrated result.

For decades our Congress and Treasury Department have crafted specialized rules to make it virtually impossible for foreign governments to tax their own people when they stash money in U.S. banks as passive investments. (NRA bank accounts related to an active U.S. trade or businesses are not protected by this rule.) Think about it; if you or I earn interest on our bank deposits it would be fully taxable and reported to the IRS via Form 1099. Should we fail to report it on our tax returns, we'd be busted big time. But for NRAs that same income is:

• exempt from U.S. income taxes;
• exempt from U.S. estate taxes;
• exempt from interest reporting requirements;
• exempt from interest withholding requirements;

Talk about a sweetheart deal. This leaves NRAs on the honor system with respect to whether they declare the income in their home country. And that's exactly how Congress wants it. Foreign tax administrators have no other way of finding out about the income, or about the bank account itself. If that's not bank secrecy, then I don't know what is.

[The only exception to the above rule, btw, is for Canadians. Since 1997 U.S. banks have been required to report interest income paid to Canadian NRAs on Form 1042-S, which functions much like Form 1099. Because the IRS possesses data on Canadian taxpayers, it can share it with Canadian revenue officials who, in return, send the IRS the data they collect on U.S. residents that receive interest income from Canadian bank deposits. This reciprocal information exchange is extremely effective at stopping crossborder tax evasion; it's also highly atypical. The policy is extremely unpopular with the banking sector, which is eager to lure in all the foreign capital it can.]

Note the obvious parallel to the UBS affair. American taxpayers are basically on the honor system when it comes to declaring income from hidden Swiss bank accounts. U.S. politicians pitch a fit when Americans take advantage of foreign bank secrecy rules to conceal income from the IRS -- and rightfully so -- yet we do the same thing to other countries?

Apparently the U.S. government's indignation over bank secrecy is, shall we say, selective. We object to bank secrecy when another country (i.e., Switzerland) erodes our tax base and prevents us from taxing our own citizens, yet we do precisely the same thing to every other country (other than Canada).

Why does Congress tolerate U.S. bank secrecy? Simple: our banks need the money.

My purpose here is not to defend Switzerland or UBS account holders who knowingly violate U.S. law. It's merely to point out a glaring double standard when I see it.

Read Comments (1)

Robert GoulderJan 12, 2011

Joaquin - thanks for your comment.

Yes, I've seen the proposed regs. Step in the right direction; they're good for

I have no objection to lower taxes or smaller government, but a tax system must
be rational -- and that means people shouldn't be able to conceal income.

Where there is neither reporting nor withholding, compliance will inevitably
suffer. That's where we are now. The new regs would help fix it.

Yes, the banking lobby will fight it tooth and nail. (Funny thing -- didn't the
gov't just bail them out to the tune of billions and billions of dollars? You'd
think that would get us some clout.)


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