Information reporting for 2006 exempt interest.

With Notice 2006-93 providing guidance on the 2006 Form 1099-INT, Interest Income, requirements for reporting exempt interest and exempt-interest dividends, the IRS has offered tenuous relief from reporting procedures. Payers must still report on substitute statements substantially the same information as required on the official form, both to the Service and payees, retroactive to the beginning of 2006 and by the same due dates as required for the official form. For backup withholding implementation, however, the relief is more helpful, in that it precludes backup withholding on payments of exempt interest and exempt-interest payments through the first quarter of 2007.

Background

U.S. persons (and certain U.S.-related persons) making payments of interest and original issue discount (OLD) generally must report such payments to the IRS, unless the payee is duly documented, or can be treated, as either foreign or an "exempt recipient." (Interest payments to non-U.S. persons may have to be reported, and possibly withheld, under different rules.) Corporations are exempt recipients for this purpose; individuals and partnerships are not. If such a payment is subject to information reporting, and the payee has not certified his or her taxpayer identification number (TIN) on Form W-9, Request for Taxpayer Identification Number and Certification (or certain other conditions exist), the payer must perform "backup" withholding at 28%.

Prior to 2006, Sec. 6049(b)(2)(B) provided that payments of exempt interest were exempt from information reporting and, thus, backup withholding. Because exempt--interest dividends paid by U.S. mutual funds are deemed to be exempt interest under Sec. 852(b)(5), this exemption from information reporting and backup withholding also covered exempt-interest dividends. In May 2006, Congress repealed this exception in the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA), effective for interest paid after Dec. 31,2005.

Notice 2006-93

In response to numerous requests from the payer community, the Service issued Notice 2006-93, which provides transition relief in connection with the 2006 Form 1099-INT requirement for reporting exempt interest.

Reporting: Exempt interest, including exempt--interest dividends, will now be reported on Form 1099-INT; certain types of otherwise exempt interest subject to the alternative minimum tax (AMT) must be separately reported on the same form. Form 1099-INT for 2006 has been revised accordingly. However, in lieu of reporting exempt interest and exempt-interest dividends on 2006 Form 1099-INT and separately identifying AMT interest, payers be permitted to file with the IRS and furnish to payees a substitute statement in specified form setting forth exempt interest and exempt--interest dividends paid for 2006. AMT interest must be reported separately to the extent possible after "reasonable effort."

Backup withholding: Since the TIPRA was enacted in May 2006, payments may have been made that would be subject to backup withholding retroactively. Accordingly, the notice waives backup withholding on exempt-interest payments made in 2006 and the first quarter of 2007.

TINs: Ordinarily, payees must certify their TINs on Form W-9 to avoid backup withholding on interest. For accounts opened before Oct. 5, 2006, payees can avoid backup withholding on exempt interest by providing their TINs in any reasonable manner, including orally or by an uncertified writing. This relief is of limited practical use; when an exempt bond is sold through a broker or redeemed, the gross proceeds will be (and always have been) subject to information reporting and backup withholding. To avoid backup withholding on gross proceeds from a sale or redemption, the payee must certify his or her TIN on Form W-9.

Exempt OID and bearer bonds: Although it generally has not been possible to issue exempt bonds in bearer form since 1982, older exempt bonds in bearer form may still be in circulation. Special provision is made for OID on exempt bonds (within the meaning of Sec. 1288) and exempt bearer bonds (i.e., state or local bonds not subject to the Sec. 149(a) bond registration requirements). For these obligations, no information reporting (under Sec. 6049) or backup withholding is required for calendar-year 2006 or thereafter, until the IRS and Treasury provide guidance. However, this provision raises the same issue as with TINs: when an exempt bearer bond is sold through a broker or redeemed, the gross proceeds will be (and always have been) subject to information reporting and backup withholding (unless the holder is foreign or an exempt recipient).

Implications

Although the notice provides welcome relief from backup withholding, and some relief from having to separately ascertain when exempt interest is AMT interest, payers will still have to compile and report information on exempt interest paid for the over four months before the statute was enacted. Many payers may still need to request relief from penalties for failure to report accurate information for 2006, on the grounds that despite their best efforts, they simply could not compile the necessary information, especially retroactively.

FROM MARC LEVY, CPA, WASHINGTON, DC