New IRS audit campaign targets financial services


The IRS announced a new compliance campaign on June 10 targeting foreign investors who may be subject to U.S. tax on effectively connected income from lending transactions engaged in through a U.S. trade or business.


The campaign centers around the safe harbor rule under Section 864(b)(2) and appears to target certain financial service entities that might serve as vehicles for foreign investors to engage in a U.S. trade or business. According to the announcement, the IRS campaign will use issue-based audits to examine applicable taxpayer’s lending transactions.


In general, a foreign person engaged in a trade or business within the United States is taxed on a net basis on its taxable income that is effectively connected with the conduct of that trade or business. A foreign person is also considered to be engaged in a trade or business within the United States if the foreign person is a member of a partnership that is engaged in a trade or business within the United States. Nevertheless, to encourage foreign investment in the United States, the Code provides a safe harbor for certain foreign investors under Section 864(b)(2).


Section 864(b)(2) generally provides that if a foreign investor trades “for his own account” only in U.S. stocks, securities or commodities, in most cases the foreign investor is not, with respect to such activities, engaged in a U.S. trade or business. Specifically, Section 864(b)(2) states that a foreign investor will not be considered to be engaged in a U.S. trade or business if such investor is “[t]rading in stocks or securities for the taxpayer’s own account, whether by the taxpayer or his employees or through a resident broker, commission agent, custodian, or other agent, and whether or not any such employee or agent has discretionary authority to make decisions in effecting the transactions.”


However, the safe harbor under Section 864(b)(2) does not apply “in the case of a dealer in stocks or securities,” including entities engaged in a lending business, or to foreign investors in partnerships engaged in such activities. Thus, the IRS campaign is focused on taxpayers that may be failing to report income subject to U.S. tax based on erroneous use of the safe harbor.


With respect to this campaign the IRS likely will examine, among other areas:

  • Financial service entities that may be originating loans in the United States
  • Foreign investors who may be inaccurately reporting effectively connected income from lending through partnerships
  • Certain fund structures that rely on treaty provisions exempting eligible foreign investors from U.S. tax when treated as engaged in a U.S. trade or business
  • Other information obtained from banks, other financial institutions, and from foreign tax authorities

The campaign appears to be in line with plans by the administration of President Joe Biden to ramp up IRS enforcement efforts, including measures that would make it harder for the large entities and high-income taxpayers to avoid or evade taxes. In addition, the IRS previously announced its intent to increase audits of large partnerships this summer. Taxpayers who may be impacted by this campaign should take note and be prepared for these new, more rigorous IRS examinations. Further, impacted taxpayers may want to consider whether a voluntary disclosure might be necessary to address any issues or transactions of concern prior to any likely examination.




Buck Buchanan

Atlanta, Georgia

  • Manufacturing
  • Technology and telecommunications
Service Experience
  • Advisory
Tax professional standards statement

This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.


More tax hot topics