A proposed Internal Revenue Service rule change aimed at cracking down on tax evaders could ultimately result in huge deposit losses for small banks, according to bankers and industry advocates.

The rule would require banks to report interest paid on accounts of nonresident aliens. IRS officials claim it would help catch U.S. citizens masquerading as foreign nationals to avoid paying taxes, and would help the United States comply with information-sharing agreements it has with other countries.

But bankers argue that without bank account confidentiality, foreign depositors would quickly shift their money to European banks, worsening the liquidity crunch many community banks are already feeling. Though the rule would apply to all banks, small ones in states with large concentrations of foreign deposits - Florida, New York, Texas, California, and Washington - would probably be hit hardest.

Mark Baran, senior tax counsel for the American Bankers Association, said it would be much easier for larger banks to absorb the losses. "Community banks that serve foreign bank deposit customers, such as those in the Miami area and border states, would suffer most," he said.

Alex Sanchez, president of the Florida Bankers Association, said banks in his state would "lose money overnight" if the rule takes effect. "We may have banks failing if these funds are withdrawn."

Wealthy Latin Americans prefer U.S. banks, he said, because they are viewed as safer than those in some Latin American countries. Also, many Latin American countries are politically unstable, and Mr. Sanchez, whose parents are Cuban, said the memory of Cubans losing their assets when Fidel Castro came to power has influenced many Latin Americans to keep their assets in the United States.

Another consideration is the safety of depositors' families, he said. If IRS information were to leak out in depositors' home countries, their families might be subject to kidnappings.

"In several countries, you don't want people knowing you have $3 million in the bank," Mr. Sanchez said.

The rule was proposed Jan. 17 and the comment period was to end Feb. 27. But bankers successfully argued for more time, and the period was extended two months.

Robert Brookes, president and CEO of $250 million-asset Eagle National Bank in Miami, estimates that 40% to 45% of its deposits come from nonresident aliens and that those customers have been with Eagle an average of 10 years. Those figures are fairly typical in south Florida, so a rule change could be disastrous for Miami-area banks, he said.

Nonresident aliens "can in a matter of nanoseconds move their money," Mr. Brookes said. "When we take in the deposits" of nonresident aliens, "we're putting that money back into the community" in the form of loans.

Neil Milner, president of the Conference of State Bank Supervisors, has written a comment letter opposing the rule, arguing that the regulations would put an unfair reporting burden on banks and eliminate any incentives for foreigners to park their money here. Moreover, he wondered what the IRS would do with the reports since the interest is not taxable.

"It's not taxable now, so what do they need the information for?" he said.

In other comment letters, the American Bankers Association and the California Bankers Association said the proposal runs counter to Congress' original intent of stimulating foreign deposits in the United States when it made interest in foreign deposits nontaxable.

"It's unfair for the banking industry to assume the role of tax police for the IRS and to assume the role of global tax police," Mr. Baran said.

Kate Hwa, an IRS lawyer who wrote the proposed rule, said the IRS has no interest in taxing the money earned on the deposits, only in monitoring the accounts in keeping with the international information-sharing agreements.

And the proposed rule has a precedent: U.S. banks must report interest paid to nonresident alien Canadians.

Not all bankers are up in arms over the proposal.

"It's tough to do too much pontificating on something that's in the proposal stage," said Robert Inman, president and chief operating officer of First Colorado Depository Corp., which takes deposits exclusively from nonresident aliens.

Despite the perception that foreign depositors are trying to avoid paying taxes in their home countries, Mr. Inman said, tax treaties already prevent many of them from getting tax relief. It is for reasons of bank safety and political stability that they put money here, he said.

Jeff Low, president of $150 million-asset Pacifica Bank in Bellevue, Wash., said the rule does not worry him. He said his foreign customers probably would not object to new reporting requirements, because most have opened accounts for business purposes rather than as a means to hide money.

"I think it would be business as usual for us," he said.

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