U.S. taxpayers having a financial interest in or signature or other authority over foreign financial accounts have been required to file a "Report of Foreign Bank and Financial Accounts" on Form TD F 90-22.1 (also known as an "FBAR") with the Treasury Department for a number of years. The FBAR reporting requirements have recently taken on additional importance, as a result of the IRS' pursuit of taxpayers with unreported foreign income and the issuance of a revised FBAR form for the 2008 reporting year defining a "financial account" to include certain equity interests in commingled funds, including mutual funds.
During a June 12, 2009, teleconference, several IRS representatives indicated their view that an interest in a foreign hedge fund constitutes a reportable "foreign financial account" for FBAR purposes. An IRS spokesperson has since confirmed the position of the IRS that interests in offshore hedge funds and private equity funds are reportable financial accounts, according to a report published today by Tax Analysts. Many believed, prior to this teleconference, that while a fund's interest in a foreign bank or brokerage account (if any) was a reportable account by U.S. managers of the fund, an interest in a foreign hedge fund or private equity fund did not itself constitute an interest in a foreign account for FBAR purposes. Reports of this teleconference triggered a flurry of activity, as tax advisors and fund managers struggled with whether and how to comply with this "new" reporting obligation prior to the June 30, 2009, filing deadline.
In an apparent response to the panic faced by taxpayers attempting to comply with this informal guidance, the IRS last week announced that taxpayers who have otherwise reported and paid tax on all their 2008 income, but only recently learned of their FBAR filing obligations and have insufficient time to complete the FBAR by the June 30 deadline, will not be subject to penalties if the required FBAR is filed by September 23, 2009, provided certain other procedures are followed. This announcement was squarely targeted at investors in foreign private investment funds, though by its terms, it applies to all FBAR filers who only recently discovered their reporting obligation.
We are advising clients who will be eligible to take advantage of this penalty relief procedure to consider postponing the filing of their FBAR reports until closer to the September 23, 2009 deadline (assuming they have otherwise reported and paid tax on all their 2008 income). Given the controversy stirred up by the June 12, 2009, teleconference, it is possible (perhaps likely) that additional guidance will be issued between now and September 23, 2009, which would exempt whole classes of investors in foreign hedge funds or private equity funds from filing FBAR reports. For example, exemptions have already been requested by certain tax exempt investors in hedge funds who cannot owe any tax. Similarly, the IRS might distinguish between interests in foreign hedge funds providing liberal withdrawal rights and interests in private equity funds generally lacking in liquidity. Investors who report fund interests for 2008 should also consider whether to simultaneously file for any prior years, as a similar procedure to avoid penalties with respect to FBARs required for years prior to 2008 is also available for taxpayers who have otherwise reported and paid tax on all their taxable income.
For taxpayers who have not reported all of their income, participation in the current IRS voluntary disclosure program may be available to limit potential civil penalty exposure and foreclose the possibility of criminal sanctions. The existing deadline to take advantage of this program is also September 23, 2009, but it is only available to taxpayers not currently under IRS investigation, and thus a delay in disclosure could prevent participation in the program if the IRS subsequently initiates an investigation proceeding.
If you have any questions regarding the new FBAR requirements for foreign hedge funds or private equity funds, please call Michael B. Gray (312-269-8086), Scott J. Bakal (312-269-8022), Matthew T. Koenders (312-269-5256) or any other attorney at Neal Gerber & Eisenberg LLP with whom you regularly work.
Because each taxpayer's situation is unique, this Alert should not and cannot be relied on as providing tax advice, and is 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.