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I.R.S. Suggests Foreign Bank Account Reporting Requirements May Apply to Interests in Offshore Hedge Funds

Client Advisory

June 25, 2009

I.R.S. officials recently offered informal advice that has the potential to significantly expand the scope of Foreign Bank Account Reporting (FBAR) requirements. U.S. persons (defined to include foreign entities doing business in the United States, as well as domestic individuals, trusts, and corporations) are required to annually disclose each of their interests in any foreign “bank and financial accounts” if the value of their investment in any such account exceeds $10,000. 

A U.S. person or entity is considered to have a financial interest in a foreign account if it is the owner of record or has legal title, or if the account is owned

  • by a corporation of which the person owns more than 50% of the stock, by vote or value,
  • by a partnership of which the person owns more than 50% of the profits or capital interests, or
  • by a trust, if the United States person either has a present beneficial interest in more than 50% of the trust’s assets, or from which the person derives more than 50% of the current income.

For years, the I.R.S. has been emphasizing that the FBAR requirements apply to investors with “any bank, securities, securities derivatives or other financial instruments accounts,” and that “such accounts generally also encompass any accounts in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund.”  In 2007, the instructions were changed to add a parenthetical reference to the effect that interests in offshore mutual funds would be considered qualifying accounts. However, on June 12th 2009, during a teleconference, three IRS officials expressed their belief that interests in offshore hedge funds can be considered “accounts in which assets are held in a commingled fund,” and therefore that U.S. persons with investments in offshore hedge funds should disclose those positions by the June 30th filing deadline.

The I.R.S. has never issued a formal statement of this position, and it is not clear what significance there is in the fact that three officials believe it. Nor is it clear that this is a reasonable interpretation of the law. Commentators have pressed the I.R.S. to issue formal guidance on this issue, but none has yet been issued.

Unfortunately, if the position is correct, it will affect a wide variety of investors. In addition to potentially affecting U.S. investors investing in offshore hedge funds, offshore feeder funds, or offshore master funds, it could apply to U.S. feeder funds that invest in offshore master funds, U.S. investors that own more than 50% of the profits or capital interests of a U.S. feeder fund which in turn invests in an offshore master fund, and investment managers with a financial interest in offshore hedge funds and similar private investment funds. 

Furthermore, the consequences of failure to properly file can be dire. Failure to file an FBAR on a timely basis may potentially result in civil or even criminal penalties. There is a civil penalty of $10,000, but it may be waived if income from the account was properly reported on the person’s federal tax return and there was reasonable cause for the failure to report. On the other hand, if the I.R.S. determines that the failure to file was willful, the penalty increases to the greater of $100,000 or 50% of the balance in the foreign account at the time of the failure to report. Criminal penalties may also be imposed for willful failures.

However, yesterday the I.R.S. released welcome guidance suggesting that taxpayers who only recently learned of their FBAR filing obligation and have not had time to gather all the necessary data may file their FBAR reports by September 23, 2009, with a note explaining why the filing was late. In this situation, if all 2008 taxable income with respect to the reported accounts has been properly reported on the person’s tax return, no penalties will be imposed. The guidance does not clarify the I.R.S.’s position on foreign partnerships. Although it is not entirely clear, it seems there would be a reasonable case for arguing that if a taxpayer disclosed all traditional foreign bank accounts by June 30, and then filed an amended FBAR report listing all qualifying offshore hedge funds before September 23, the I.R.S. should not impose penalties.

The September 23 deadline is also important with respect to returns for prior years. The I.R.S. has in place a program to mitigate the consequences of failure to report foreign accounts for years prior to 2008. By voluntarily coming forward before September 23, such taxpayers can resolve outstanding tax liabilities, and will generally be able to eliminate the risk of facing criminal charges and reduce their exposure to penalties.    In light of the stated position of certain I.R.S. officials and the potentially severe penalties, we believe that U.S. investors who hold interests in offshore hedge funds, offshore partnerships and similar private investment vehicles should contact us immediately regarding whether and how they should report their interests.

The FBAR form, I.R.S. Form TD F 90-22.1 can be found on the I.R.S. website at:
http://www.irs.gov/pub/irs-pdf/f90221.pdf.


Questions regarding this advisory should be addressed to Howard J. Barnet (212-238-8606, barnet@clm.com), Andris J. Vizbaras (212-238-8698, vizbaras@clm.com), Dan Pittman (212-238-8854, pittman@clm.com) or Jinsoo J. Ro (212-238-8833, ro@clm.com).

Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. © 2017 Carter Ledyard & Milburn LLP.
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