FBAR the Door

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By Dirk J.J. Suringa, Esq. Covington & Burling LLP, Washington, DC

During the last few months there has been a significant increase in activity, and taxpayer anxiety, concerning the foreign bank account report (“FBAR”) form, TD F 90-22.1. Treasury regulations issued under the Bank Secrecy Act of 19701 (rather than the Internal Revenue Code) require that each U.S. person with a financial interest in, or signature or other authority over, a foreign bank, securities, or other financial account (or accounts) with an aggregate value exceeding $10,000 report the account and “provide such information as shall be specified in a reporting form prescribed by the Secretary.”2 The regulations provide no further guidance regarding the scope and nature of the filing requirement, leaving that to the Form TD F 90.22-1 instructions.

Instructions to forms are not the most helpful form of guidance even when comprehensive,3 and the instructions to Form TD F 90-22.1 (“the FBAR Instructions”) leave many questions unanswered. Given that the penalties for failure to comply can be quite serious,4 answering these questions should be given a high priority by the IRS. The IRS already has attempted to address some of the uncertainties regarding the FBAR filing requirement through the release of Frequently Asked Questions (“FAQs”) on the IRS website5 and elsewhere,6 and the IRS has recently announced, in Notice 2009-62,7 that it does intend to write regulations concerning at least certain FBAR issues. Proposed legislation8 that would treat the FBAR requirement as a tax filing should not be viewed as a prerequisite for promulgating comprehensive regulatory guidance.

The following is a list of some of the issues that merit guidance:

Exception for domestic subsidiaries of foreign publicly-traded corporations. The FBAR Instructions provide an exception from the requirement to report foreign financial accounts for certain officers and employees of domestic corporations directly or indirectly owned by domestic publicly traded corporations. By its terms, this exception does not apply to officers and employees of domestic corporations directly or indirectly owned by foreign publicly traded corporations. It should. The reporting obligations imposed on employees of large, foreign-owned U.S. affiliated groups are just as burdensome and duplicative as those that would be imposed on U.S.-owned affiliated groups if they were not covered by the exception. Imposition of the filing requirement on foreign-owned groups also implicates the non-discrimination provisions of U.S. bilateral income tax treaties, which prohibit ownership-based discrimination against the subsidiaries of foreign corporations resident in treaty jurisdictions.

Definition of financial account. The FBAR Instructions define a financial account to include “any account[s] in which the assets are held in a commingled fund, and the account owner holds an equity interest in the fund (including mutual funds).” Recent comments by IRS employees have indicated a belief that this definition covers interests in foreign private equity funds and foreign hedge funds. It is unclear, however, whether the IRS distinguishes between funds structured as partnerships or corporations, whether lock-up periods matter in determining whether the investment is treated as an account, what level of liquidity in the fund would cause it to be treated as a “commingled fund,” and whether active management matters in determining whether a fund is subject to reporting. The IRS also apparently takes the position that an interest in a PFIC or QEF is a foreign financial account that requires an FBAR filing,9 even though the definition in the instructions excludes mere ownership of “stock certificates,” and even though a foreign corporation can meet the definition of a PFIC or QEF without being a “commingled fund” (e.g., a real estate holding company with only passive rental income). Notice 2009-62 provides a filing extension until June 30, 2010 for “persons with a financial interest in, or signature authority over, a foreign commingled fund.” Regulations are promised in the interim. The notice also requests comments regarding the possibility of applying the principles of §§1297 and 1298(b) to determine whether an interest in a foreign entity should be subject to FBAR reporting. Given the lack of existing guidance on how to interpret those provisions,10 it might make more sense to stick with the majority-ownership rule for equity ownership already found in the existing regulations. At some point, the burden of determining how and when to comply with the FBAR reporting rules outweighs the money-laundering risks associated with minority interests in foreign mutual funds.

Exception for banks. The FBAR Instructions provide a filing exception for officers or employees of “a bank which is currently examined by Federal bank supervisory agencies for soundness and safety.” An employee of such a bank need not report signature authority over a foreign financial account “maintained by the bank,” provided the employee has no financial interest in the account. If this exception were read literally, it would not appear to apply: (1) to securities dealers because they are not banks; (2) to banks that are subject to examination but not “currently” under examination; (3) to banks that are examined by State rather than Federal bank supervisory agencies; or (4) to any bank with respect to a financial account that is not “maintained by the bank.” Such a cramped reading of the instructions appears implausible, but there are no authorities to comfort practitioners and taxpayers trying to assess their filing obligations. For example, if a bank is hired to manage a U.S. pension fund's investment portfolio, one investment of which is in a foreign private equity fund, would the bank employee managing the U.S. pension fund need to file an FBAR because the foreign fund is not “maintained by the bank?”

Signature Authority. The FBAR Instructions provide that a person has signature authority over a foreign financial account “if such person can control the disposition of money or other property in it by delivery of a document containing his or her signature (or his or her signature and that of one or more other persons) to the bank or other person with whom the account is maintained.” If this instruction is read literally, every U.S. person has signature authority over every foreign financial account in the world: any U.S. person could dispose of funds in any account by delivering to the bank a document containing his or her signature “and that of one or more other persons” -- i.e., the person or persons actually authorized to disburse the funds. This, of course, cannot possibly be the intent, but in fact the quoted passage is actually the narrower part of the definition as written! The remainder of the definition extends the filing requirement to “a person who can exercise comparable power over an account by communication with the bank or other person with whom the account is maintained, either directly or through an agent, nominee, attorney, or in some other capacity on behalf of the U.S. person, either orally or by some other means.” The IRS should narrow the scope of this definition, not only for the sake of tax administration, but also for the sake of its own enforcement efforts.11

Delinquent Filing Requirement. On June 24, 2009, the IRS posted an FAQ on its website indicating that otherwise compliant taxpayers who “only recently learned of their FBAR filing obligation and have insufficient time to gather the necessary information to complete the FBAR” should file the FBAR on a delinquent basis under procedures announced in the IRS Voluntary Disclosure Practice. Taxpayers must file their 2008 FBAR, attach a statement explaining why the FBAR is filed late, and send a copy of the delinquent FBAR and “a copy of the 2008 tax return” to the Philadelphia Offshore Identification Unit by September 23, 2009. Notice 2009-62 extended this due date for commingled-fund filers, as described above, and also for “persons with signature authority over, but no financial interest in, a foreign financial account.” While this reprieve was welcome news, it did not accompany any significant (or formal) guidance concerning the scope of the filing requirement. Moreover, taxpayers who do not fit into one of the two categories stated in Notice 2009-62 still must file by September 23, 2009. For them, the FAQ provides guidance, but the FAQ remains unclear in certain respects. In the case of individual filers, for example, it is unclear whether the copy of the 2008 return required to be filed is the original 2008 return or an amended return that presumably now checks the required box on Schedule B to reflect the foreign account.

The inability of taxpayers to file the form electronically, which is unlikely to change before September 23, 2009, or June 30, 2010, means that a potentially huge volume of paper is about to be unloaded on the IRS. Rumors already are circulating about FBAR filings being rejected because of excessive volume or even because additional paperwork (including the required explanatory statement) was attached to the filing. As an administrative matter, delaying the required filing date for all taxpayers, particularly for the filing of the additional five years of “delinquent” FBAR forms for taxpayers previously unaware of their filing obligation, would seem prudent for everyone involved. Notice 2009-62 was a first good step in this regard, but further steps should be taken.

This commentary also will appear in the September 2009 issue of the Tax Management International Journal.

1 31 USC §5314.

2 See 31 CFR §103.24.

3 See, e.g., Casa de La Jolla Park, Inc. v. Comr., 94 T.C. 384, 396 (1990) (“[E]ven if the instructions were misleading, the sources of authoritative law in the tax field are the statute and regulations and not government publications.”).

4 The civil penalty for non-willful violations is a fine of up to $10,000 and for willful violations is a fine of up to the greater of $100,000 or half the account value. See 31 USC §5321(a)(5). Criminal violations may result in the imposition of a fine of up to $250,000 and five years imprisonment. See 31 CFR §103.59(b). If the violation occurs as a part of a pattern of illegal criminal activity or while violating another law of the United States, violations may result in a fine of up to $500,000 and ten years imprisonment. See 31 CFR §103.59(c).

5 See, e.g., Press Release, Internal Revenue Service, September 23 Deadline for Some FBAR Filers (June 24, 2009), available at http://www.irs.gov/newsroom/article/0,,id=210174,00.html.

6 See, e.g., Toscher & Stein, “FBAR Enforcement--Five Years Later,” J. of Tax Prac. & Proc., June-July 2008, at 37, 43 (providing as an exhibit a write-up of a National Phone Forum on FBAR compliance, held on June 20, 2007, which write-up SB/SE Counsel apparently approved).

7 2009-35 I.R.B. __.

8 See Senate Finance Committee Discussion Draft to Improve Tax Compliance Regarding Offshore Transactions, 111th Cong., §4 (3/12/09).

9 See id. at 56.

10 See, e.g., Notice 88-22, 1988-1 C.B. 489 (providing “temporary” guidance on the PFIC asset and income tests).

11 See, e.g., U.S. v. Bucey, 876 F.2d 1297, 1308-09 (7th Cir. 1989) (reversing a conviction for material concealment of facts due in part to ambiguities in the instructions to Treasury Form 4789), cert. denied, 493 U.S. 1004 (1989); see also U.S. v. Shearson Lehman Bros., Inc., 650 F. Supp. 490, 496 (E.D. Pa. 1986) (treating the filing requirement in Treasury Form 4789 as “a legislative rule promulgated without the required notice and comment procedure, and therefore … ineffective in the context of a criminal prosecution”); compare U.S. v. Murphy, 809 F.2d 1427, 1430 (9th Cir. 1987) (reversing conviction due to ambiguities in the form) with U.S. v. Hurley, 63 F.3d 1, 13 (1st Cir. 1995) (upholding conviction after form was revised and clarified).

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