There are few tax reporting guidance updates for July. This is not unusual for the middle of the summer. But the lack of new developments gives us a chance to consider a couple of topics that may need to be addressed in the coming months: negative interest rates and cryptocurrency tax reporting. For those preparing for next year’s 1099 filings, we have a brief note on an updated Publication 1179.
- SIFMA sent a short letter to the IRS in July highlighting the fact that a negative interest rate environment may pose issues for withholding agents dealing with withholding (and 1042-S reporting) on non-U.S. counterparties or account holders.
- Virtual currency tax reporting regulations were included in the IRS priority guidance plan for 2019-20, but no regulations have been issued as of the end of the plan year at June 30.
- Planning ahead for the next Form 1099 filing season, brokers and other withholding agents should know that the IRS updated its Publication 1179 in July.
1. Negative Interest Rates
SIFMA sent a short letter to the IRS in July highlighting the fact that a negative interest rate environment may pose issues for withholding agents dealing with withholding (and 1042-S reporting) on non-U.S. counterparties or account holders. For example, a U.S. fund deposits money into an account at a non-U.S. bank but is required to pay an amount to the non-U.S. bank reflective of a so-called negative interest rate. What is the character and source of that payment?
The SIFMA letter dated July 9, 2020 mentions four specific scenarios where cross-border withholding (and therefore 1042-S reporting) issues can arise. The following is taken from the SIFMA letter:
- Cash Deposits: In this scenario, a U.S. financial institution has a deposit account with a non-U.S. bank. Typically, the non-U.S. bank would pay interest on the amount deposited. In a negative rate environment, the U.S. financial institution would make a negative rate payment to the non-U.S. bank with respect to the funds held in the deposit account.
- Margin Loan: A non-U.S. client borrows cash from a U.S. broker to purchase U.S. securities. Typically, the non-U.S. client would pay interest to the U.S. broker on the borrowed funds and the securities are used as collateral. In a negative rate environment, the U.S. broker would pay the non-U.S. client an amount based on the negative rate.
- Derivatives: Cash collateral is pledged by a U.S. financial institution to a non-U.S. counterparty. Usually, the non-U.S. counterparty would pay interest on the cash collateral. In a negative rate environment, the U.S. financial institution would make a negative rate payment to the non-U.S. counterparty with respect to the funds held as collateral.
- Repurchase Transactions (“repos”): A non-U.S. client that owns U.S. Treasury securities (repo seller) sells them to a U.S. counterparty (repo buyer) for cash. The repo buyer agrees to resell the securities at a later date to the repo seller at the original price plus an amount determined by reference to an interest rate. The incremental amount is termed “Price Differential.” When positive, the Price Differential is generally treated as interest when paid by the repo seller. In low interest rate environments, the Price Differential may be negative and there would be a negative rate payment.
The letter argues that the IRS should treat the payment being made for so-called negative interest not as interest but as a payment that is non-U.S. source, perhaps a non-U.S. sourced custodial service fee.
For domestic reporting, if a customer has an account with a bank or broker and is being charged to deposit funds, the financial institution likely has no reporting requirement. The payment (whatever its character) is being paid to (rather than by) the financial institution. But the scenario noted in the SIFMA letter relating to a broker lending funds in a margin account may be a potential area of concern if the broker actually pays the customer for the privilege of margin borrowing (though this may seem odd). In that case, how that payment is characterized would determine applicable Form 1099 reporting type.
Guidance from the IRS would be helpful in both the Form 1099 and Form 1042-S/NRA withholding context.
2. Cryptocurrency Tax Reporting
Another area where brokers and other financial institutions are awaiting guidance from the IRS is regarding the obligation of brokers and other financial intermediaries to report respect to cryptocurrency transactions that they may help to facilitate. Virtual currency tax reporting regulations were included in the IRS priority guidance plan for 2019-20, but no regulations have been issued as of the end of the plan year at June 30. However, the IRS noted in a recent webinar hosted by the American Bar Association Section on Taxation that the virtual currency reporting regulations are indeed being worked on.
In the meantime, the practice with respect to virtual currency tax reporting has been disparate. Different institutions have taken different approaches and formats. But given that the new regulatory project is being framed under section 6045 of the code, this would imply the coming rules would generally align virtual currency reporting with broker proceeds reporting. Section 6045 currently covers broker tax reporting and is conducted utilizing Form 1099-B. Current reporting systems should be reviewed with this in mind.
Moreover, many financial institutions have come to understand that tax reporting is in many respects not just about regulatory requirements but customer service. News out of Australia in July provide a good example of this in the context of crypto. Following news that the Australian tax authority earlier this year had been sending out some 350,000 letters to taxpayers to remind them of their obligations to pay tax on cryptocurrency transactions, three Australian crypto exchanges announced in July that they were partnering with crypto tax software provider Koinly to provide customers with tax-relevant reports for their crypto transactions on the exchanges. The service is intended to assist customers with their individual tax reporting.
From a Form 1099 tax reporting perspective, brokers have generally created customer-friendly packets for year-end tax reporting that marry both the art and science of tax reporting. Tax reporting needs to fulfill IRS reporting requirements but also needs to be customer friendly. As customers realize the increasing complexity of complying with tax rules related to crypto transactions, brokers and other financial intermediaries may from a customer relationship perspective be tasked to help, irrespective of regulatory requirements. But from an efficiency standpoint, the goal would be the ability to align regulatory compliance with a positive customer experience.
3. Updated Pub. 1179
Planning ahead for the next Form 1099 filing season, brokers and other withholding agents should know that the IRS updated its Publication 1179 in July. Publication 1179, titled General Rules and Specifications for Substitute Forms 1096, 1098, 1099, 5498, and Certain Other Information Returns, provides specifications with regards to the format and other requirements relating to certain informational returns and statements, including recipient composite Form 1099 statements that brokers generally provide to customers.
The updated publication reflects the addition of new Form 1099-NEC to the Form 1099 series and the redesigned Form 1099-MISC and the fact that certain forms (including Form 1099-OID) have changed to “continuous use” and may not be updated for each year.
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