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Congress and the I.R.S. Take Aim at Foreign Financial Accounts

Client Advisory

March 23, 2010

In the past several weeks, there have been two significant developments for U.S. persons with investments outside the country. On March 18, the President signed into law the Hiring Incentives to Restore Employment Act (the “HIRE Act”). This legislation includes as a revenue offset major provisions of the previously proposed Foreign Account Tax Compliance Act. Late last month, the Department of the Treasury and the I.R.S. published Proposed Regulations and other guidance exempting for 2009 and prior years most investments in offshore hedge funds and private equity funds from the foreign bank account reporting (“FBAR”) rules, which require disclosing the existence of foreign financial accounts.  The guidance also addresses the FBAR requirements for trusts and certain other entities.

HIRE Act

Congress and the I.R.S. believe that the level of U.S. taxpayer compliance with laws requiring the reporting of overseas assets and income was, until recently, quite low, resulting in significant evasion of U.S. taxes. The HIRE Act includes a series of provisions designed to bring greater transparency to the foreign investments of U.S. taxpayers. Congress expects these provisions to raise $8.7 billion over ten years, mainly by increasing compliance with existing tax laws by U.S. individuals with foreign financial accounts. Whether or not these revenue estimates are reasonable, the changes will certainly result in increased scrutiny of, and significant compliance burdens on, such taxpayers. 

Congress has long required U.S. financial institutions to file annual information returns (Form 1099) reporting income of U.S. individuals. However, there are significant limits on the authority of the I.R.S. to collect similar information from foreign financial institutions. Under the new legislation, however, starting in 2013 foreign financial institutions will be subject to a 30% withholding tax on income they derive from certain U.S. financial assets, unless they agree to file annual reports with respect to each U.S. individual with an account at the institution. Each report would have to state the account balance as well as gross receipts and gross withdrawals or payments made during the year. For this purpose, foreign financial institutions include foreign banks, as well as foreign securities and commodities brokers and any other foreign entities (including hedge funds and private equity funds) engaged in the business of accepting deposits, holding assets for others, or investing, reinvesting, or trading in securities interests, partnership interests, or commodities.

A similar rule would apply to U.S. income earned by foreign corporations, trusts and partnerships. Under present law, payors of income to such foreign entities are generally not required to withhold if the foreign entity certifies that it is the beneficial owner of the income being paid. This allows U.S. investors to invest through corporations and similar entities, the ownership of which is opaque to the I.R.S. The new law would require foreign entities to provide withholding agents with either the name, taxpayer identification number and address of each of their “substantial U.S. owners” (meaning U.S. persons who own 10% or more of the foreign entity), or a certification that the payee does not have any substantial U.S. owners. Foreign entities refusing to provide this information would be subject to 30% withholding on income derived from U.S. financial assets made after December 31, 2012. The rule would not apply to publicly-held corporations and certain other types of entities presenting a low risk of tax evasion. 

The new law also substantially increases the penalties for individuals failing to disclose their foreign investments. Effective immediately, the law imposes a penalty of up to $50,000 on individuals who fail to disclose ownership of foreign investments valued, in the aggregate, at $50,000 or more. Further, there is a  40% penalty on the amount of any understatement of tax attributable to undisclosed foreign assets. Finally, the normal three year statute of limitations is extended to six years where income omitted from a return relates to one or more reportable foreign assets and exceeds $5,000. 

A number of other provisions are aimed specifically at foreign trusts. The Act codifies current regulations establishing that foreign trusts established by U.S. persons have U.S. beneficiaries if any current, future, or contingent beneficiary is a U.S. person, and creates a presumption that a foreign trust has U.S. beneficiaries if a U.S. person directly or indirectly transfers property to the trust. These rules will make it more likely that a foreign trust will be treated as a grantor trust as to any U.S. settlor of such trust. The law also provides that, effective immediately, the uncompensated use of any trust property will be treated as a payment from the trust, in the amount of the fair market value of the use. This would apply, for example, to a residence held in a foreign trust and used by a U.S. beneficiary. The new law also establishes a penalty of at least $10,000 for failure to file certain information returns relating to foreign trusts.

Treasury Actions

On February 25, the Treasury Department published Proposed Regulations, an Announcement and two Notices regarding FBAR reporting. Notice 2010-23 states that the I.R.S. will not enforce the reporting requirement with respect to 2009 and prior years against persons having interests in (or signature authority over) a foreign hedge fund, private equity fund or other "foreign commingled fund" (other than a foreign mutual fund). 

The proposed regulations would make other changes and clarifications to existing law, including the following:

  • Beneficiaries of trusts would not be required to file FBARs in respect of accounts held by the trust unless:
    1. the trust is a grantor trust and a U.S. person is treated as the owner of the trust,
    2. the beneficiary has a beneficial interest in more than 50% of the assets or receives more than 50% of the income of the trust, or
    3. the trust was established by a U.S. person, and he or she retains control over the trust's "protector."

However, if the trust, trustee or other agent is a U.S. person who files an FBAR with respect to the trust’s accounts, the beneficiary does not have to file.

  • Foreign annuities and foreign insurance contracts with cash surrender values would be considered "financial accounts."
  • Beneficiaries of IRAs and pension plans would not be required to file FBARs, though the plans themselves would be, as would any person with signature authority over the accounts or plans.

The proposed regulations contain numerous other refinements which we will be pleased to discuss on an individual basis.


Questions regarding this advisory should be addressed to Howard J. Barnet, Jr. (212-238-8606, barnet@clm.com), Jerome J. Caulfield (212-238-8809, caulfield@clm.com), Michael I. Frankel (212-238-8802, frankel@clm.com), or Dan Pittman (212-238-8854, pittman@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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