Interest on backup withholding liabilities is deductible

Plain-English summary

Chief Counsel Advice addressed whether financial institutions could deduct interest paid on backup-withholding liabilities disclosed and paid under closing agreements. The advice concluded that the interest is deductible under IRC § 163 and is deductible when accrued under §§ 446 and 461. It distinguished the interest from the backup-withholding payments themselves, which the advice states are not deductible under § 275.

Ruling snapshot

• Question: May financial institutions deduct interest paid on backup-withholding liabilities?
• Outcome: Advice given
• Key authorities: IRC §§ 163, 275, 3406, 446, and 461

Full text (IRS public release)

ID: CCA-311123-11 Number: 201115024
Release Date: 4/15/2011
Office: ------------
UILC: 163.00-00

From: --------------------
Sent: Friday, March 11, 2011 12:31 PM
To: --------------------------
Cc: --------------- ---
Subject: Brief summary of facts for question of deductibility of backup withholding taxes ---------

Hi ----------- -

We have a number of banks that have neglected to backup withhold under § 3406 of the Internal Revenue Code. Under § 3406, when a taxpayer makes a “reportable payment” (e.g., certain dividend or interest payments), but fails to meet the requirements of § 3406(a) (e.g., does not provide its TIN to the bank receiving the payment), then the bank receiving the payment is required to withhold a statutory amount (backup withhold) from the taxpayer’s payment.

Currently, the Service has several cases involving financial institutions that are “coming clean” by voluntarily disclosing to the Service that they failed to backup withhold payments of interest, dividends, and proceeds from the sale of stocks and securities made to individuals, corporations, partnerships, trusts, and other entities. The financial institutions were required to backup withhold because these payments fell into one of the “red flag” categories listed in § 3406(a).

As part of this voluntary disclosure, the financial institutions are entering into closing agreements with the Service under which they will agree to pay the correct amount of backup withholding liability pursuant to § 3406, plus interest. The banks are precluded by § 275 from deducting the backup withholding payments. However, the banks argue that they should be permitted to deduct the interest.

After coordinating with ------------we --------------conclude that the interest paid by these financial institutions on their backup withholding liabilities is deductible under § 163. Furthermore, the interest is deductible when accrued under §§ 446 and 461. See 2002 IRS CCA LEXIS 71 (Issue #2) (attached).

If you have any further questions on this issue, please do not hesitate to contact me at -
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