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Florida Bankers Association v. United States Department of Treasury

United States District Court, District Circuit

January 13, 2014

FLORIDA BANKERS ASSOCIATION, et al., Plaintiffs,
v.
UNITED STATES DEPARTMENT OF TREASURY, et al., Defendants.

MEMORANDUM OPINION

JAMES E. BOASBERG, United States District Judge

In 2012, the Internal Revenue Service issued new income-reporting requirements aimed at detecting and deterring tax cheats at home and abroad. Specifically, the regulations required U.S. banks to report the amount of interest earned by accountholders residing in foreign countries. These reports will help the United States comply with various exchange treaties, under which other countries provide our Government with information about American taxpayer assets held in offshore accounts in exchange for information from us about foreign assets sitting in U.S. banks.

The Florida and Texas Bankers Associations now challenge those reporting requirements, alleging that the regulations violate the Administrative Procedure Act and the Regulatory Flexibility Act. The Bankers Associations contend, in a Motion for Summary Judgment, that the IRS got the economics of its decision wrong and that the requirements will cause far more harm to banks than anticipated. Because the Service reasonably concluded that the regulations will improve U.S tax compliance, deter foreign and domestic tax evasion, impose a minimal reporting burden on banks, and not cause any rational actor – other than a tax evader – to withdraw his funds from U.S. accounts, the Court upholds the regulations and grants the Government’s Cross-Motion for Summary Judgment.

I. Background

A. Regulatory Background

This case revolves around new IRS reporting requirements for U.S. banks. For some time now, banks have been required to report interest earned by U.S. citizens and residents. See 26 U.S.C. § 6049; Form 1099-INT. That interest is taxed by the IRS. 26 U.S.C. §§ 1, 63(a). Recently, however, the Service also began requiring banks to report the interest paid to certain non-resident aliens, despite the fact that such aliens do not pay U.S. taxes on their interest. See 26 U.S.C. § 871(i)(2)(A). A brief overview of the motivation for such regulations and their procedural background may prove helpful here.

1. Tax Compliance and Off-Shore Accounts

The IRS is on a constant quest to bridge the so-called “tax gap” – that is, the $450 billion gap between what taxpayers owe the government and what they actually pay. See The Tax Gap, IRS, http://www.irs.gov/uac/The-Tax-Gap (last visited Jan. 10, 2014). Part of this gap is caused by a lack of taxpayer candor regarding assets retained in off-shore accounts. While U.S. citizens and residents owe taxes on the interest meted out by foreign banks, much of those off-shore earnings go unreported and undetected. See, e.g., Administrative Record at 5822 (IRS Commissioner Doug Schulman’s Statement on UBS/Voluntary Disclosure Program (November 16, 2010)) (revealing over 15, 000 undisclosed foreign accounts).

This problem arises because the IRS’s collection efforts are “based on a system of self-reporting.” United States v. Bisceglia, 420 U.S. 141, 145 (1975). Essentially, “the Government depends upon the good faith and integrity of each potential taxpayer to disclose honestly all information relevant to tax liability.” Id. Honesty, however, may not be every American taxpayer’s greatest virtue. As a result, the Government also relies on third-party reporting, matching, and verification to confirm the correct amount of taxpayer liability and to encourage accurate self-reporting. See, e.g., AR 5827 (Citizens for Tax Justice, The Tax Cheaters’ Lobby Is Wrong About IRS Proposed Regulations (January 31, 2011)) (confirming that taxpayer honesty climbs when third parties disclose income to IRS).

Getting foreign banks to report income earned by U.S. taxpayers, however, has proven to be a challenge. Many countries, for instance, make such reporting illegal. See, e.g., id. (noting foreign bank-secrecy laws); AR 6454 (OECD Model Tax Convention on Income and on Capital, Article 26, Exchange of Information (July 22, 2010)) (attempting to put an end to such laws). As a result, the United States has entered into treaties with at least 70 foreign governments to provide for the exchange of tax information upon request. See Rev. Proc. 2012-24 § 3; AR 6816 (Model Tax Convention on Income and on Capital, Commentary on Article 26, Exchange of Information (July 22, 2010)); see, e.g., United States v. Stuart, 489 U.S. 353 (1989). At least one treaty – our exchange agreement with Canada – provides for the automatic exchange of that information. See Rev. Proc. 2012-24 § 4; AR 6885-907 (Protocol Amending the Convention Between the United States and Canada With Respect to Taxes on Income and on Capital (September 21, 2007)).

Reciprocity is the key to success in such treaties. If the United States does not gather and report tax information for foreign accountholders, then other countries have little incentive to provide us with similar information. See Guidance on Reporting Interest Paid to Nonresident Aliens, Final Regulations, 77 Fed. Reg. 23, 391, 23, 391 (April 12, 2012) (effectiveness of exchange agreements “depends significantly . . . on the United States’ ability to reciprocate”); AR 7281-82 (Comment, Financial Accounting and Corporate Transparency (FACT) Coalition (May 18, 2011)) (reiterating the point); AR 7215-16 (Comment, Individual from Switzerland (February 22, 2011)) (same). This is the backdrop against which the challenged regulations must be considered.

2. Statutory and Regulatory Scheme

a. Prior Regulatory Action

Even before the promulgation of the regulations at issue in this case, the IRS required banks to report the interest earned by at least some non-resident aliens – namely, Canadian citizens. Because our agreement with Canada involves the automatic exchange of tax information, the IRS long ago tasked banks with collecting data on Canadian citizens’ accounts. See Information Reporting and Backup Withholding, 61 Fed. Reg. 17, 572 (Apr. 22, 1996). Banks share this data with the IRS through Form 1042-S, which reports the interest paid to each Canadian accountholder, and through Form 1042, which contains the total amount of interest paid to those accountholders in a given tax year.

In 2001, the Government proposed extending these reporting requirements to nonresident aliens from all countries. See Guidance on Reporting of Deposit Interest Paid to Nonresident Aliens, 66 Fed. Reg. 3925 (Jan. 17, 2001), corrected at 66 Fed. Reg. 15, 820 (Mar. 21, 2001) and 66 Fed. Reg. 16, 019 (Mar, 22, 2001). The proposal, however, was never enacted. See Guidance on Reporting of Deposit Interest Paid to Nonresident Aliens, 67 Fed. Reg. 50, 386 (Aug. 2, 2002).

b. 2011 Notice of Proposed Rulemaking

A decade later, that proposal was revived. See Guidance on Reporting Interest Paid to Nonresident Aliens, Notice of Proposed Rulemaking; Notice of Public Hearing; and Withdrawal of Previously Proposed Rulemaking, 76 Fed. Reg. 1105 (Jan. 7, 2011). In the IRS’s 2011 Notice of Proposed Rulemaking, the Agency put forward regulations that would require U.S. banks to report the interest paid to all non-resident aliens. See id. The Agency claimed that such regulations were warranted as a result of the “growing global consensus” that “cooperative [tax] information exchange[s]” were necessary to apprehend tax cheats. Id. at 1106. “[R]outine reporting” of non-resident tax information would, it said, “strengthen the United States exchange of information program” and thus “help to improve voluntary compliance” with existing tax laws by U.S. taxpayers. Id. The IRS also invited comments and scheduled a public hearing. Id.

Although many of the comments received from financial institutions were critical of the proposal, see AR 7370-83 (Summary of Public Hearing on Proposed Regulations, Internal Revenue Service (May 18, 2011)), others were supportive. The Financial Accountability and Corporate Transparency Coalition, for example, noted that “America should not be a haven for international tax evaders.” Comment, FACT Coalition at 7281. Senator Carl Levin commended the proposal for deterring the use of “offshore mechanisms to hide taxable income.” AR 7097 (Comment, Sen. Carl Levin, Chairman, Permanent Subcommittee on Investigations (April 12, 2012)). He further praised the proposal for creating no new burden on banks, since most banks “already have in place comprehensive automated systems to produce needed information to the IRS” from the existing Canadian reporting requirements. Id. at 7099.

Other comments, conversely, noted that the regulations seemed overbroad. See, e.g., AR 6017 (Hearing Statement, Before the House Committee on Financial Services, 112th Congress, J. Thomas Cardwell, Former Commissioner, Florida Office of Financial Regulation (October 27, 2011)). While the United States has exchange agreements with only 70 countries, the proposed amendments required reporting for all 196 countries worldwide. Commenters also worried about the confidentiality of the information collected and the potential risk of “capital flight” – that is, non-residents’ closing their accounts and withdrawing their money due to the new regulations. See AR 6994 (Florida Congressional Delegation Letter to the President (March 2, 2011)); 7209 (Comment, Zions Bancorporation (Norman Merritt, Executive Vice President) (March 24, 2011)).

c. Final 2012

Rule The final rule, which was issued in 2012, responded to these comments by preserving the core of the amendment while somewhat narrowing and clarifying the regulations. 77 Fed. Reg. 23, 391. Pursuant to the final rule, effective January 1, 2013, banks are now required to report interest payments to non-resident aliens, but only for aliens from countries with which the United States has an exchange agreement. The reports utilize the same forms already employed to ...


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