Potential FBAR filing changes

Under current rules, U.S. investors with a "financial interest in or signature or other authority over" certain "foreign financial accounts" must file a "Report of Foreign Bank and Financial Accounts" (Form TD F 90-22.1, or FBAR) with the Internal Revenue Service. Recent changes to the FBAR filing instructions and informal guidance from an IRS official indicate that offshore entities, such as offshore hedge funds and private equity funds, may be "financial accounts" for which investors must file FBAR. Consequently, PE funds and hedge funds may want to alert clients investing in an offshore fund of the possibility that an FBAR may need to be filed. The deadline to file is June 30, but the IRS recently announced that investors have until Sept. 23 to file without incurring penalties, provided certain conditions are met.

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An FBAR must be filed by "each United States person who has a financial interest in or signature or other authority over any foreign accounts, including bank, securities, or other types of financial accounts, in a foreign country, if the aggregate value of these financial accounts exceeds $10,000 at any time during the calendar year." "Financial accounts" include, among other things, securities accounts and savings accounts. Significantly, "financial accounts" include any account in which the assets are held in a commingled fund and the account owner holds an equity interest in the fund (including mutual funds) that are located outside of the U.S. During a June 12 teleconference sponsored by the American Bar Association and the American Institute of Certified Public Accountants, an IRS official took the position that an offshore hedge fund would be a "foreign financial account," and this informal guidance has brought to the attention of fund managers and financial institutions the potential application of FBAR filing requirements to these types of investments.

However, there is still much confusion as to the scope of foreign financial accounts for which an FBAR filing must be made. For instance, some have argued that an offshore feeder fund should not be considered a foreign financial account to the extent the offshore feeder fund invests solely and directly in a domestic master fund.

FBAR filing presents a number of practical challenges to investors. There is no certainty regarding the proper scope of the foreign financial account definition, nor with respect to who is required to make the filing for an investor's foreign accounts (i.e., who has a financial interest in or signature or other authority over a foreign financial account), and the limited IRS guidance available explicitly contemplates multiple filings for the same account. FBAR's substantive filing requirements, while not extensive, will also be burdensome and confusing for most filers. However, in some instances, investors required to file FBAR may make simplified filings (i.e., investors required to report 25 or more foreign financial accounts) or consolidated filings (i.e., for 50%-owned corporations).

Over the past few years, the IRS has stepped up its enforcement of the FBAR filing requirements and has launched initiatives to increase compliance. Investors failing to file may face civil penalties from $500 per violation up to the greater of $100,000 or 50% of the account balance, and in some circumstances, criminal penalties may apply.

In light of IRS enforcement initiatives, the possibility of significant penalties for a failure to file, and investors' general confusion regarding their filing obligations, many managers of offshore PE funds and hedge funds have begun alerting investors to the possibility that an FBAR filing needs to be made. Typically, such notices include: (i) a description of the FBAR filings requirements; (ii) a statement noting there is confusion over whether a filing needs to be made with regard to offshore funds; (iii) the possibility of civil and criminal penalties; (iv) the fund's address to be used on the FBAR; and (v) a recommendation that the investor seek guidance from their legal counsel.

As noted above, the annual filing is June 30, but the IRS recently announced that filers have until Sept. 23 to file FBAR for the 2008 calendar year if they have only recently learned of their obligation to file FBAR, insufficient time to gather the necessary information, and reported and paid all 2008 taxable income, if any. FBAR filings made after June 30 will still be considered delinquent and should be filed with a statement explaining the delinquency, but the IRS will not impose penalties for a failure to file.

Jennifer E. Eller and Michael P. Kreps are attorneys at the Groom Law Group, where their practices focus on Erisa's fiduciary responsibility provisions.

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