Treasury Attempts to Clarify FBAR Filing Obligations and IRS Issues 2009 FBAR Filing Exemptions

W.C. Fields once said, "if at first you don’t succeed, try, try again. Then quit. There’s no point in being a damn fool about it."

Fortunately for tax professionals and taxpayers, the U.S. Department of the Treasury has greater fortitude than Fields, and has continued to try to clarify the Report of Foreign Bank and Financial Accounts (FBAR) filing obligation.

On February 26, 2010, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued Proposed Regulations to amend the Bank Secrecy Act (BSA)¹ provisions that apply to the FBAR. The Proposed Regulations are intended to bring much needed clarity to the annual filing obligation. Comments are requested no later than April 27, 2010. Because the Proposed Regulations are not effective until they are finalized, also on February 26, the Internal Revenue Service (IRS) released Announcement 2010-16 and Notice 2010-23, which provide timely administrative relief and exempt certain taxpayers from having to file 2009 FBARs. There would likely be much less interest in these issues were it not for the severity of the penalties associated with a failure to file an FBAR.

FBAR Background

It is important to remember that the FBAR is an informational return – not a tax return. It is a byproduct of the BSA, which was first enacted in 1970 out of concern that financial institutions in tax haven jurisdictions were being used by U.S. persons to hide the proceeds of their illegal activities, evade tax, and engage in other criminal activities. The BSA specifically imposed responsibility on the Secretary of the Treasury to promulgate regulations that would promote compliance; be useful in criminal, tax, regulatory, intelligence and counter-terrorism matters; and counter money laundering.

Originally, the Secretary delegated authority to investigate possible FBAR compliance issues to the IRS, and the authority for civil enforcement of FBAR violations to FinCEN – an arm of the Treasury Department that has responsibility for overseeing and implementing policies to detect and prevent money laundering and terrorist financing. On April 10, 2003, FinCEN delegated its enforcement authority for FBARs to the IRS. Since then, the IRS has had the ability to investigate noncompliance with the FBAR, assess and collect civil penalties associated with such noncompliance, and use the full investigative arsenal available to the Service. Nevertheless, the sole authority to clarify the FBAR filing obligations remains with FinCEN.

Who Is Required to File an FBAR?

Generally, a U.S. person with a financial interest, signature authority or other authority over foreign financial accounts has to file an FBAR if at any point during the calendar year the aggregate value of all such foreign accounts equals or exceeds $10,000, even if for one day.

Prior to the revised FBAR being introduced in the fall of 2008, a U.S. person was defined to include a U.S. citizen or resident, and a domestic corporation, partnership, estate or trust. The Proposed Regulations define the term "United States person" in much the same way: it includes citizens and residents of the United States, as well as any domestic entity. The term "resident" is defined by reference to section 7701(b) and the regulations thereunder. Consequently, even though a nonresident alien never had to worry about filing an FBAR to report whether he/she was "in and doing business in the U.S.," as a result of the relief provided in Announcement 2010-16 and Notice 2010-23, if a nonresident alien classifies as an income tax resident under the substantial presence test, such individual will have to file an FBAR to report their worldwide accounts. In many jurisdictions, individuals go through significant expense to obtain privacy for purely personal safety reasons, and not for money laundering or any financial criminal enterprise. Resorting to the use of the income tax test for residency alleviates the government from providing effective guidance as to what qualifies as "in and doing business," but the number of persons who could be affected increases tremendously. The Proposed Regulations indicate that the estimated number of affected individuals and entities is 400,000, and that a great majority will likely come from this group.

Limited liability companies are included within the definition of a "domestic entity." Interestingly, an entity will have to file whether or not it has made an election to be disregarded. The consequence is that a nonresident alien owner of a disregarded entity may have to file an FBAR regardless of whether such person qualifies as a U.S. income tax resident.

The definition for "United States" is expanded to include Indian lands as well as U.S. territories and possessions. FinCEN believes it is necessary to expand the definition for the "United States" because taxpayers hide their residency in an effort to "obscure the source of their income or location of their assets."²

Which Accounts Are Reportable?

FinCEN believes that only accounts at institutions where taxpayers have a formal relationship need to be reported. The length of the relationship is irrelevant; the fact that a relationship existed controls the filing obligation. "For this purpose, an account means a formal relationship with such person to provide regular services, dealings and other financial transactions." An exception exists for taxpayers who do not have a relationship with the institution, but rather who use the institution for a transaction such as wiring funds or purchasing money orders. These are the two examples provided in the Proposed Regulations, and it is not clear if a distinction exists between an individual who sends, as opposed to receives, a wire. It would appear that someone who receives a wire from an institution such as a Western Union should not have to file an FBAR, provided the individual does not otherwise have a relationship with the institution.

Whereas the FBAR instructions provide one definition for a "financial account," the Proposed Regulations include individual definitions for a bank account, a securities account and other financial accounts. The focus in each case is on the kinds of financial services provided to the taxpayer by the institution, as is detailed in the following:

1. Bank Account. This term is defined to include a "savings deposit, demand deposit, checking or any other account maintained with a person engaged in the business of banking." Institutions in which taxpayers can deposit funds and redeem the funds at a later date with interest are also included within the definition. Although this is a better description than existed previously, the definition has not really been expanded.
2. Securities Account. A definition for these types of accounts did not previously exist. The term is now defined to include "an account maintained with a person in the business of buying, selling, holding, or trading stock or other securities."
3. Other Financial Accounts. Although this term previously appeared in the definition for a "financial account," FinCEN believes that compliance will improve if it specifies the types of relationships that must be reported. The following relationships are included within the definition:

• an account with either a financial agency that is in the business of accepting deposits or with a person who accepts deposits as a financial agency
• an insurance policy that has a cash value or an annuity policy
• 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
• an account with a mutual fund or similar pooled fund which issues shares available to the public provided the investment’s net asset value is regularly determined and the investment offers regular redemptions

In the latter case – a mutual fund or similar pooled fund – FinCEN has elected not to include hedge funds, private equity funds and similar types of pooled investment companies in the definition of "other financial account," but notes that it reserves the right to do so at a later date. It has agreed to wait until the legislative landscape has cleared to see if regulation affecting such investments will be enacted. If not, it would appear that FinCEN might require such investments to be reported on an FBAR.

4. Exempt Accounts. The Proposed Regulations continue to exempt certain types of accounts from the reporting regime, and they include a few additional such accounts. These are generally accounts affiliated with the government, those in which the owner’s access to funds are limited or tenuous.

• Correspondent or nostro accounts remain exempt, as these accounts are used by the institutions to make bank-to-bank transfers.
• An account in an institution known as a "United States military banking facility" (or "United States military finance facility") operated by a U.S. financial institution designated by the United States government to serve U.S. government installations abroad, even if the U.S. military banking facility is located in a foreign country, is not a reportable account.
• An account of an international financial institution of which the United States government is a member is an exempt account.
• An account of a department or agency of the United States, an Indian Tribe or any political subdivision of a state – or a wholly owned entity, agency or instrumentality of the foregoing – is not reportable.
• Participants and beneficiaries in a qualified retirement plan in accordance with Internal Revenue Code sections 401(a), 403(a) or 403(b), as well as owners and beneficiaries of IRA and Roth IRA accounts created in accordance with section 408 and 408(a), are exempt from filing an FBAR to report the existence of foreign investments held by the plan.
• As indicated above in our discussion of reportable accounts, if an individual does not have a relationship with an institution but receives funds through a one-time transaction such as a wire transfer, the account is not reportable. Care is recommended, however, because short-term accounts, such as escrow accounts, are reportable.
• As stated below in our discussion of financial interests, certain trust beneficiaries are exempt from filing an FBAR provided an FBAR is filed by the trustee or an agent of the trustee.

No Change in Definition of "Foreign" Account

For an account to be reported on an FBAR, it must be foreign (i.e., located outside the United States). There has been no change to the definition; an account will continue to be considered foreign if it is located outside the United States, on Indian lands, in U.S. territories and U.S. possessions.

Which Financial Interests Are Reportable?

The definition of a "financial interest" has been expanded to include the owner of a foreign trust under the grantor trust rules. There is also a catchall now that states that a financial interest shall exist in any foreign account when a U.S. taxpayer holds ownership through an entity that is designed to evade the reporting requirement. This simply appears to be another way of requiring individuals to report their indirect ownership of an account regardless of how such ownership is actually titled. For FinCEN, this is an anti-avoidance rule designed to capture individuals who are engaging in nefarious activities. The Proposed Regulations do not otherwise change the definition of a financial interest.

It would have been a pleasant surprise had the regulations clarified the reporting requirement for beneficiaries of a foreign discretionary trust. Such persons are classified as having a financial interest if the U.S. person has a beneficial interest in more than 50 percent of the assets, or when such person receives more than 50 percent of the current income. It often is not possible for the beneficiary to determine the percentage of income that he/she received, and it is even more difficult to determine the percentage of ownership an individual has in a discretionary trust.

In an effort to avoid duplicative filings, trust beneficiaries are exempt from filing an FBAR if the trustee of a foreign trust or agent of the trust is a U.S. person who files an FBAR for the trust. Note that the trust beneficiary will have to file a Form 3520 for any year in which the trust makes a distribution, even if there is no FBAR filing obligation. In providing this exemption, FinCEN acknowledges that in some instances, a trust or its trustees are in a better position to be aware of the presence of foreign financial accounts, as well as whether the beneficiary has greater than a 50 percent interest. However, FinCEN fails to acknowledge that in a number of instances the beneficiary has no communication with the trustee. As a result, the universe of persons who might benefit from this exemption could be limited.

What Is Included by Signature or Other Authority?

The term "signature or other authority" includes the situation where an individual (alone or in conjunction with others) has control over the disposition of money, funds or other assets held in a foreign financial account by delivering instructions (in writing or otherwise) to a person where the account is maintained. Previously, certain persons were exempt from filing an FBAR to report their signature or other authority provided: (1) the accounts belonged to an employer; (2) the employee did not have their own financial interest in a foreign account; and (3) the employee was advised that the employer had filed its own FBAR. The Proposed Regulations expand on the number of instances in which an individual with signature authority will be excused from filing an FBAR. They include the following:

• Officers and employees of financial institutions that have a federal functional regulator, and certain entities that are publicly traded, are exempt from filing an FBAR as long as the individual does not have a financial interest of their own.
• Officers and employees of a bank that is examined by the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the FDIC, the Office of Thrift Supervision or the National Credit Union Administration are exempt from filing an FBAR as long as the individual does not have a financial interest of their own.
• Officers and employees of a financial institution that is registered with and examined by the Securities and Exchange Commission or Commodity Futures Trading Commission are exempt from filing an FBAR as long as the individual does not have a financial interest of their own. Similarly, the individual does not need to determine whether the employer has filed its own FBAR in order to qualify for the exception.
• Officers and employees of banks that are examined by a federal banking agency are exempt from filing an FBAR as long as the individual does not have a financial interest of their own. Similarly, the individual does not need to determine whether the employer has filed its own FBAR in order to qualify for the exception.
• Officers and employees of an Authorized Service Provider registered with the SEC are exempt from filing an FBAR as long as the individual does not have a financial interest of their own. This exception is designed to cover persons affiliated with mutual funds and employed by fund service providers.
• Officers and employees of an entity with a class of equities or securities that is listed on any U.S. national securities exchange are exempt from filing an FBAR as long as the individual does not have a financial interest of their own. Similarly, the individual does not need to determine whether the employer has filed its own FBAR in order to qualify for the exception. However, if the employee or officer works for the U.S. subsidiary of such an entity, the exemption is not as broad. In such circumstances, the employee must make certain that the U.S. subsidiary is listed on a consolidated FBAR filed by its parent. If the parent does not file an FBAR, then the employee would have to file FBARs to report his or her signature authority over the parent’s foreign accounts. FinCEN advises that these persons will have reduced filing obligations.
• Officers and employees of domestic corporations are exempt from filing an FBAR as long as the individual does not have a financial interest of their own, and the corporation has more than $10 million in assets and more than 500 shareholders.

Special Rules

FinCEN will permit consolidated filings for individuals with a financial interest in 25 or more foreign financial accounts or those with signature or other authority over 25 or more foreign financial accounts. Additionally, individuals who own more than 50 percent of an entity that is required to file an FBAR can file a consolidated FBAR to report the interest held by the entity, as well as their individual interest.

The Proposed Regulations include a draft of new FBAR instructions that provide an address for overnight delivery and procedures for seeking verification that FBARs were received by the Detroit Service Center. The overnight mailing address is: IRS Enterprise Computing Center, Attention CTR Operations Mailroom, 4th Floor, 985 Michigan Avenue, Detroit, Michigan, 48226. Verification may be obtained in accordance with the instructions 90 days after the filing due date.

Reasonable cause continues to be available, but it would appear to only apply to persons who are delinquent in filing. The exception reads as follows: "if there is reasonable cause for the failure to file and the balance in the account is properly reported, no penalty will be imposed."

Notice 2010-23

Among other things, Notice 2010-23 finally resolves an issue that began to fester on June 12, 2009, when an IRS representative stated on a telephone conference call sponsored by the American Institute of Certified Public Accountants, the ABA Section of International Law Committee on International Taxation, and the ABA Section of Real Property Trust and Estate Law that FBARs were required by taxpayers with an interest in a foreign hedge fund, foreign private equity fund or foreign partnership if those investments were operated similar to a mutual fund ("foreign commingled funds"). Traditionally, many professional tax advisors, as well as many of those in the financial industry, believed FBARs were not required in order to report such foreign commingled funds. This was the first time the IRS had publicly stated that the definition for a foreign account reached such investments, and the Service has been retreating from the position ever since.

The Notice states that "the IRS will not interpret the term ‘commingled fund’ as applying to funds other than mutual funds with respect to FBAR" for 2009 and prior years. This marks the second IRS notice in eight months to provide guidance on the issue. As a result of the significant outcry following the June 2009 conference call, the IRS issued Notice 2009-62 on August 7, 2009 (2009 Notice), which suspended the need for taxpayers to report their investment in a foreign commingled fund until June 30, 2010. Although Notice 2010-23 does not state affirmatively that an FBAR will not be required in subsequent years by taxpayers with an interest in a foreign commingled fund, the Proposed Regulations provide such affirmation – at least for now.

Notice 2010-23 also provides administrative relief for taxpayers who have not had a financial interest in a foreign financial account, but who have had either signature authority or other authority over such an account. The 2009 Notice gave these taxpayers until June 30, 2010, to file FBARs for calendar year 2009 and prior calendar years. Taxpayers now have until June 30, 2011, to report their authority over foreign financial accounts in calendar year 2010 and prior calendar years.

Finally, the Notice also advises taxpayers who qualify for the relief offered in it to check the "no" box on Schedule B of their Form 1040 asking whether the taxpayer has an interest in or authority over a foreign financial account.

Announcement 2010-16

On September 30, 2008, the IRS posted a revised FBAR form on its website, which was to be used for all filings subsequent to December 31, 2008. One of the changes on the revised FBAR was an expansion of the definition of U.S. person to include nonresident aliens "in and doing business in the United States." As a result of the lack of guidance and significant confusion associated with the expanded definition, the IRS then issued Announcement 2009-51, which suspended the requirement for persons who are not citizens, residents or domestic entities to file an FBAR for the 2008 tax year. And on February 26, 2010, the IRS released Announcement 2010-16, which similarly suspends the necessity of a nonresident alien to file an FBAR regardless of whether they were doing business in the United States. Again, the Proposed Regulations provide much needed clarity as to the class of persons required to file FBARs.

Summary

FinCEN released the Proposed Regulations in an effort to help tax advisors give clear guidance to taxpayers regarding when the need to file an FBAR exists. Although the regulations provide much greater clarity than previously existed – and increase the available exceptions – the greatest impact they have may be on nonresident aliens. Because the IRS has discretion to assess draconian penalties for a taxpayer’s failure to file an FBAR, the conservative approach – to simply file, if in doubt – remains the best approach, all things considered.

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¹ The Bank Secrecy Act is codified at 12 U.S.C. §§ 1951-1959 and 31 U.S.C. §§ 5311-5330.

² Tax Haven Banks and U.S. Tax Compliance, Staff Report, Permanent Subcommittee on Investigations, Senate Comm. on Homeland Security and Governmental Affairs, at 8 (7/17/08).