Community bankers are urging lawmakers to pressure the Internal Revenue Service into withdrawing a proposed rule that would require U.S. banks to report to the IRS any interest paid on deposit accounts of nonresident aliens.

In letters to members of the House and Senate this week, the Independent Community Bankers of America said that the proposed rule, issued in February, would likely result in mass withdrawals of deposits, causing "significant economic harm" to banks and the communities they serve.

"We urge all policymakers to recognize that this onerous new IRS reporting requirement would be an unwarranted burden on community banks and would have a direct, adverse impact on investment, lending and the economic recovery," ICBA President and Chief Executive Officer Camden R. Fine wrote in the letter dated June 2.

The IRS proposed a similar rule in 2001, but withdrew it after it was broadly rejected. In a notice published in the Federal Register, the IRS said it was reintroducing the proposal largely to encourage greater cooperation between countries when it comes to tracking the deposits of nonresidents. In short, if the U.S. cracks down on nonresidents here, other countries might reciprocate and report to the IRS how much interest U.S. residents are earning in foreign banks.

"Requiring routine reporting to the IRS of all U.S. bank deposit interest paid to any nonresident alien individual will further strengthen the United States' exchange of information program, consistent with adequate provisions for reciprocity, usability, and confidentiality in respect of this information," the IRS said in its notice for rulemaking.

But in his letter to Congress, Fine said that the proposal would undermine the "confidentiality that nonresident aliens have come to expect in our banking system [and] would likely result in the abrupt withdrawal of their deposits and would deter future deposits."

Nonresident aliens hold nearly $4 trillion in U.S. banks, according to the U.S. Chamber of Commerce, and Fine said these deposits are a significant source of capital for community banks.

Losing these deposits, he wrote, "would immediately reduce banks' capital levels at the very time when banks desperately need capital to sustain an economic recovery."

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