The U.S. Financial Crimes Enforcement Network ("FinCEN"), a bureau of the U.S. Department of the Treasury (the "Treasury Department"), issued final regulations in February 2011 to clarify the requirement that certain U.S. persons annually report foreign bank and other financial accounts using Form TD F 90-22.1 (the "FBAR"). The regulations became effective on March 28, 2011, and apply to certain foreign financial accounts in which "a person subject to the jurisdiction of the United States" (a "U.S. Person") had a financial interest, or over which an individual U.S. Person had signature authority, during calendar years beginning with 2010. Although the regulations are not retroactive, FinCEN has indicated that filers may rely on the final regulations to determine their filing obligations for prior year FBARs if the filing of such reports was properly deferred under previous Treasury Department guidance. The IRS has issued revised FBAR instructions reflecting the new regulations.
In addition to the FBAR requirement, there are disclosure requirements for individuals with certain foreign financial assets in the recently enacted Hiring Incentives to Restore Employment Act (the "HIRE Act"), which uses a different set of rules and is effective for tax years beginning after March 18, 2010.
Summary Of FBAR Filing Rules
The FBAR requirement applies to each U.S. Person, including a citizen or resident of the United States, and any entity - such as a corporation, partnership, trust, or limited liability company - organized under the laws of the United States. To be covered by the FBAR requirement, a U.S. Person must have a "financial interest" in, or "signature or other authority" over, the type of account described below.
A "financial interest" exists when a foreign financial account is held (i) in a U.S. Person's name for such person's own benefit or the benefit of others (including non-U.S. persons); (ii) by an agent, a nominee, an attorney, or a person acting in some other capacity on behalf of a U.S. Person; (iii) by a corporation of which a U.S. Person owns, directly or indirectly, more than 50 percent of the total value of shares or of the voting power of all shares; (iv) by a partnership or other entity in which a U.S. Person owns, directly or indirectly, more than 50 percent of the voting power, total value of the equity interest or assets, or interest in profits; or (v) by a trust, if a U.S. Person (1) is the trust grantor and has an ownership interest in the trust for U.S. federal tax purposes, or (2) has either a present beneficial interest in more than 50 percent of the assets or receives more than 50 percent of the current income.
"Signature or other authority" exists when a U.S. Person (alone or with another) has authority "to control the disposition of money, funds, or other assets held in a financial account by direct communication (whether in writing or otherwise) to the person with whom the financial account is maintained." Signature authority reporting applies only to individuals.
Foreign financial accounts include the following types of accounts located outside the United States: (i) a bank account, including a savings or checking account, or "any other account with a person engaged in the business of banking"; (ii) a securities account, defined as "an account with a person engaged in the business of buying, selling, holding, or trading stock or other securities"; (iii) a mutual fund or similar pooled fund "which issues shares available to the general public that have a regular net asset value determination and regular redemptions"; (iv) an account with a person that acts as a broker or dealer for futures or options transactions in any commodity on, or subject to, the rules of a commodity exchange or association; or (v) an account that is an insurance or annuity policy with a cash value.
Although investments in offshore private equity and hedge funds are not currently reportable as foreign financial accounts, the Treasury Department "reserves" the authority to require FBAR reporting. However, such investments would be disclosed under the separate HIRE Act disclosure requirements.
Regarding "custodial" or "omnibus" accounts at U.S. financial institutions - such as banks - through which a U.S. person maintains foreign assets that are held abroad in the name of the bank, if the U.S. customer can access such foreign assets only through the U.S. "global custodian bank," the U.S. customer would not have to file an FBAR with respect to assets held in the account. In this situation, the U.S. customer maintains an account with a financial institution located in the United States. However, if the U.S. customer can directly access the foreign holdings by contacting a foreign entity, the U.S. customer would have a foreign financial account and thus an FBAR obligation with respect to that account.
In general, a filer must report certain basic information about each foreign account, including its precise maximum value in U.S. dollars and the mailing address of the foreign financial institution where the account is maintained. A U.S. Person with an interest in, or reportable signature or other authority over, 25 or more accounts may utilize a simplified reporting method, but must be prepared to provide additional information to the Treasury Department upon request.
The FinCEN regulations provide exceptions to FBAR reporting for the following types of individuals who have signature authority over, but no financial interest in, the foreign financial accounts of their employers: (i) officers and employees of banks and other depository institutions that are subject to functional regulation by a federal agency that also examines them for Bank Secrecy Act (the "BSA") anti-money laundering compliance; (ii) officers and employees of entities the shares of which are listed on any U.S. national securities exchange; (iii) officers and employees of a "financial institution" (as defined by the BSA) that is registered with and examined by the Securities and Exchange Commission (the "SEC") or the Commodity Futures Trading Commission, an exception that generally covers officers and employees of registered securities broker-dealers, mutual fund advisers, futures commission merchants, and introducing brokers but does not generally apply to registered investment advisers because advisers are not "financial institutions" within the meaning of the BSA regulations; and (iv) officers and employees of "Authorized Service Providers" (defined as entities registered with and examined by the SEC that provide services to an investment company registered under the Investment Company Act of 1940) but only with respect to signature or other authority over a foreign financial account maintained by an investment company registered with the SEC.
IRS Notice 2010-23 postponed until June 30, 2011 the deadline for reporting by individuals with signature or other authority over, but no financial interest in, foreign financial accounts for 2009 and prior years. FinCEN has stated that individuals who relied on this 2010 Notice and did not file FBARs in 2010 or prior years may base their determination regarding the filing of prior year reports on the provisions of the new regulations that are favorable to them, as long as they "properly deferred" their FBAR filings in accordance with previous Treasury Department guidance.
The FinCEN release on the regulations provides two clarifications with respect to trust beneficiaries. First, it states that FinCEN does not intend for a beneficiary of a discretionary trust to have a financial interest in a foreign financial account "simply because of his status as a discretionary beneficiary." Second, the release states that FinCEN does not intend to include a remainder interest within the scope of the term "present beneficial interest" for purposes of filing an FBAR. Under the revised regulations, a beneficiary either having a present beneficial interest in more than 50 percent of the assets or receiving more than 50 percent of the current income of the trust is no longer required to report the trust's foreign financial accounts if the trust, or the trustee or agent of the trust, is a U.S. Person that files an FBAR with respect to such accounts.
An entity that is a U.S. Person and that owns, directly or indirectly, a more than 50 percent interest in an entity that also is required to file an FBAR is permitted to file a consolidated report on behalf of itself and the other entity. This is a revision of previous law, under which only corporations could file a consolidated FBAR.
In a new provision, the revised regulations provide that a U.S. Person that causes an entity to be created for the purpose of evading the FBAR reporting requirement will be deemed to have a financial interest in the foreign financial accounts of which the entity is the owner of record or the holder of legal title.
Nonwillful failure to file a required FBAR can result in a civil penalty of up to $10,000 for each violation. A willful failure to file can result in (1) a civil penalty, per violation, of 50 percent of the amount in the account at the time of the violation or $100,000, whichever is greater, or (2) a criminal penalty of up to $250,000 and/or five years in prison. A violation of the reporting requirement in connection with a violation of another federal law, or as part of a pattern of certain unlawful activity, can subject the violator to a fine of up to $500,000 and/or ten years in prison. In addition, failing to file a required FBAR, or filing an FBAR containing materially false information, may result in a separate violation of federal law, which criminalizes the act of knowingly and willfully making false statements to the government.
Summary Of HIRE Act Filing Requirements
Under the HIRE Act, "any individual" must report on a statement attached to his or her tax return information substantially similar to that required to be disclosed on the FBAR. This disclosure requirement is in addition to the FBAR filing requirement and is effective for tax years beginning after March 18, 2010. The disclosure statement will be due on the due date of the individual's federal income tax return. Therefore, in general, most individual taxpayers would have to file this statement beginning in 2012 with respect to interests held at any point during 2011.
Individuals are subject to this separate tax return reporting requirement if they hold interests in "specified foreign financial assets," which include non-U.S. stocks, non-U.S. bonds, financial instruments and contracts issued by non-U.S. persons, interests in foreign entities, and interests in any financial accounts maintained by foreign financial institutions, if the aggregate value of such assets exceeds $50,000. A "foreign financial institution" is defined as any foreign entity engaged primarily in the business of investing, reinvesting, or trading in securities, partnership interests or commodities, or any interest therein; any entity that accepts deposits in the ordinary course of a banking or similar business; or any entity that as a substantial portion of its business holds financial assets for the account of others.
The required disclosures include, for a stock or security, the name and address of the issuer and the class or issue of the stock or security; for a financial instrument or contract, sufficient information to identify the instrument or contract, and the names and addresses of all counterparties; and for a foreign financial account, the name and address of the foreign financial account and the account number.
The Treasury Department has authority to issue regulations exempting certain classes of assets from the category of specified foreign financial assets. If an individual does not provide sufficient information to demonstrate the aggregate value of specified foreign financial assets, the HIRE Act presumes that the value of such assets is greater than $50,000. Unlike with the FBAR filing requirement, there is no exemption to this reporting requirement for interests in foreign hedge funds, private equity funds, or venture capital funds.
The penalty for failure to disclose is $10,000 per year plus an additional $10,000 per month for up to five months if the taxpayer has been mailed a notice of a failure to disclose, such that the total maximum penalty would be $60,000. The HIRE Act contains a "reasonable cause" exception, but reasonable cause does not include "[t]he fact that a foreign jurisdiction would impose a civil or criminal penalty on the taxpayer (or any other person) for disclosing the required information." Understatements of tax related to income from undisclosed foreign financial assets will result in a penalty of 40 percent of the underpayment of tax.
Joseph A. Riley is a Partner in the Tax Department of the New York office of Willkie Farr & Gallagher, LLP; Russell L. Smith is Special Counsel and Barbara A. Block is an Associate in the Government Relations Department of the firm's Washington, DC office.