IRS Extends Deadline for FBAR Reporting Requirements for Hedge Funds, Private Equity Funds and Similar Commingled Investments

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Background:

In the IRS Strategic Plan for 2009-2013, offshore case development is at the top of the IRS’s (or “The Service”) list of emerging high risk areas. Current IRS Commissioner Doug Shulman issued a statement proclaiming, “My goal has always been clear—to get those taxpayers hiding assets offshore back into the system.” The Service has backed his words with strong actions by expanding reporting requirement for foreign bank accounts and increasing the number of international IRS specialists. It is anticipated that The Service will continue to expand the audit pool and strengthen the assessment of penalties in this area in the coming years.

The landscape of financial reporting for foreign investments changed dramatically on June 12, 2009 during an American Bar Association teleconference involving a panel of IRS representatives. In the teleconference the IRS declared offshore hedge funds qualify as “foreign financial accounts” subject to the report of foreign bank and financial account requirements (FBAR). However, due to the confusion and uncertainty involving the FBAR filing requirements and obligations, the IRS finally issued Notice 2009-62 allowing additional time until June 30, 2010 to meet FBAR filing obligations for (1) persons with signature authority over but no financial interest in, a foreign financial account, and (2) persons with a financial interest in, or signature authority over, a foreign commingled fund.  Only these two types of filers are eligible for this relief.  This relief would include off-shore hedge funds that are considered commingled funds.

What is the Purpose of FBAR?

The general purpose of the FBAR is for each United States person (see discussion below) to disclose a financial interest or signature authority in financial accounts located in foreign jurisdictions, if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year. 

Who is considered a United States Person?

Notice: On June 5, 2009 the IRS issued Announcement 2009-51, 2009-25 I.R.B. 1105, which stated that the IRS is temporarily suspending the filing requirement of the FBAR for those persons who are not U.S. citizens, residents, or domestic entities. The following are considered U.S. persons:

• A citizen or resident of the United States
• Any individual, and all forms of business entities, trust and estates “in and doing business in the United States”
• Individuals that have signing authority over a non-US account (if such person can control the disposition of money or other property)

What is considered a Financial Account?

• Bank accounts (savings, demand, checking, deposit or any other account maintained with a financial institution)
• Security accounts (mutual funds, brokerage accounts and securities derivatives accounts)
• Accounts where the assets are held in a commingled fund and the account owner holds an equity interest in the fund
• Any other account(s) maintained in a foreign financial institution or with a person doing business as a financial institution

What is Financial Interest?  

• Accounts for which the U.S. person is the owner of record or has legal title, whether the account is maintained on his/her own benefit or for the benefit of other including non-United States persons.
• Accounts where the owner of record or holder of legal title is a person acting as an agent, nominee, or in some other capacity on behalf of a U.S. person. This includes:
• A partnership in which the U.S. person owns interest in more than 50% of the profits
• A trust in which the U.S. person either has a present beneficial interest in more than 50% of the assets or received more than 50% of the current income.

When to File the FBAR:

The FBAR (form TD F 90-22.1) is not an income tax return and should not be mailed with any income tax returns. The FBAR must be mailed on or before June 30 of the following year to: U.S. Department of the Treasury, P.O. Box 32621, Detroit, MI 48232-0621. Unlike with federal income tax returns, requests for an extension of time to file an FBAR are not granted.

Penalties for Failure to File the FBAR:

The IRS has announced that it intends to vigorously enforce penalties for FBAR non-compliance, going as far back as 6 years (the statute of limitations under the Bank Secrecy Act, Title 31). Under the penalty provisions found in 31 U.S.C. 5314(a)(5), it is possible to assert civil penalties for FBAR violations in amounts that exceed the balance in the foreign financial account. The maximum annual penalties for failure to file are as follows:

Civil Penalties:

• $10,000 for non-willful noncompliance
• $100,000 or 50% of the amount of underlying accounts balance at the time of the violation if determined to be willful
   

Criminal Penalties:

• $250,000 fine and 5 years imprisonment
• $500,000 fine and 10 years imprisonment if in tandem with any other US law

What to do if you properly reported all taxable income but never filed a FBAR:

 

File a delinquent FBAR report and provide a statement explaining why the report is late by September 23, 2009.

In this situation, the IRS will not impose a penalty (see Penalties for Failure to File above) for the failure to file the FBAR.

What to do if you did NOT properly report all taxable income in the past and wish to voluntarily disclose the information to the IRS:

An overview of the IRS initiative for the Voluntary Disclosure Program* provides for the following with regard to FBARs:

Notice: the Voluntary Disclosure Program will end September 23, 2009.

• This program is not available to taxpayers that have already been contacted by the IRS regarding this issue.
• Penalty framework provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving all offshore tax issues that are complete and presented with full cooperation of taxpayers in all areas, including payment.
• Assurance that those taxpayers who qualify will not be subject to criminal or civil fraud penalties (see penalties for failure to file above).
• Is the only means by which offshore non-compliance may be resolved
• Covers the six year period 2003 to 2008.

* If you have already been contacted by the IRS regarding this issue the Voluntary Disclosure Program is not available.

Voluntary Disclosure Penalty Framework:

If the taxpayer comes forward and has their voluntary disclosure accepted by the IRS, they face this potential scenario:

• File six years of amended or delinquent tax returns and FBARs.
• Pay all taxes and interest due for the six years
• Pay a 20% accuracy penalty or 25% delinquency penalty
• Pay a one-time 20% penalty in the year with the highest aggregate account balance.  In certain circumstances this penalty will be reduced to 5%.

If the taxpayer does NOT come forward and the IRS discovers their offshore activities they can face this potential scenario:

• Tax and accuracy-related penalty, plus interest
• FBAR penalties for willful failures to file complete and correct FBARs
• The potential of having the 75% fraud penalty
• The potential of substantial additional information return penalties if the foreign account or assets are held through a foreign entity such as a trust or corporation and required information returns were not filed
• Examination could also lead to criminal prosecution

How Can We Help You?

With the new rule changes and reporting requirements it is important to fully understand your exposure in this area. The voluntary disclosure program can be an asset to a taxpayer if utilized correctly; however, it is important to understand your rights. If you feel you have a reporting requirement or need to make a voluntary disclosure you should contact a tax professional who can assist you in this complicated process.

For more information contact:

Joseph P. Pirrello, CPA
Partner, Tax Services
jpirrello@wiss.com

Michael La Motta, CPA
Partner-in-Charge, Tax Services
mlamotta@wiss.com