IRS Changes Position on Reporting for Investments in Foreign Hedge Funds and Private Equity Funds

On June 12, 2009, personnel from the IRS and Treasury Department participated in a teleconference hosted by the American Bar Association and the American Institute of Certified Public Accountants designed to address open questions regarding the calendar year 2008 Foreign Bank Account Reporting (FBARs) that must be received by the IRS by June 30, 2009. A representative of the IRS on the call suggested that the definition of financial account includes an interest in a foreign hedge fund, and that an FBAR filing would be required if the hedge fund was serving a function similar to a mutual fund. While there was no specific reference to private equity funds, or to other types of investment funds, there is no reason to believe that the IRS will not view such funds in a similar manner and that an FBAR requirement may also exist for investors in these funds.

 

The instructions to the FBAR do not mention offshore hedge funds under the definition of a "financial account," nor has the IRS issued any guidance regarding the inclusion of offshore hedge funds under this definition. This lack of guidance comes both prior to, and after, the June 12th conference and even after repeated requests for guidance from the Managed Funds Association (MFA) and certain professional organizations. Prior to this teleconference, it was uncertain whether a hedge fund fell under the definition of a "financial account," so most advisors adopted the position that there was no FBAR filing requirement generated by an investment in a foreign hedge fund.

 

This issue is generating tremendous upset in Washington as it impacts countless investors and tax-exempt organizations (not to mention the latter's FIN 48 calculations). Comments sent to Treasury by Caplin & Drysdale indicate the adverse impact this change has on certain tax-exempt entities. The manner in which the announcement was made and the timing of the announcement just three weeks before the deadline for completion of the forms is beyond what one should reasonably expect from its taxing authorities. Nevertheless, the penalties associated with noncompliance are too large to ignore and practitioners have been scrambling to comply with the rules.

 

Because Treasury has made offshore reporting a high profile issue, we do not think Treasury is going to back down from this position (although it may not impose penalties for those "missing" this issue this year). When asked to comment on a June 25 Wall Street Journal article that quoted an unnamed IRS source as saying that off shore fund administrators must file a FIBAR, IRS spokesman Bruce Friedland confirmed the statement and said the IRS's position is that investments in foreign hedge funds and private equity funds are reportable for FBAR purposes.

 

In the case of most hedge fund and private equity investments, the information needed to complete the required filing will have to be provided by the hedge fund or private equity manager. Use the attached checklist to accumulate the information.

 

June 30th is the deadline for filing the current year Report of Foreign Bank and Financial Accounts, Treasury Form TD F 90-22.1 (FBAR). Unlike the rule for tax forms, FBAR forms are deemed filed when received by the IRS, not when postmarked. (As a result, use of certified mail with return receipt requested is recommended.) No extension of time to file is granted.

 

Persons required to file the form who do not do so by June 30th are subject to a penalty. For a willful violation, the penalty can be as high as the greater of $100,000 or 50% of the amount in the foreign account. For a nonwillful violation that is not corrected and for which there is no reasonable cause, the penalty can be as high as $10,000. Further, practitioners may be subject to Office of Professional Responsibility (OPR) disciplinary action if they do not exercise due diligence with respect to their client’s FBAR filing requirements.

 

 

Until further guidance is issued by the IRS, a FBAR should be filed by the following taxpayers with respect to investments in offshore funds:

 

 

 

In apparent response to the confusion over the new rules, the IRS posted on its Web site a revised version of frequently asked questions concerning voluntary disclosure of offshore bank accounts. In Answer #43, the IRS said that investors and tax-exempt organizations that have reported and paid taxes on all 2008 taxable income but only recently learned they have an FBAR filing obligation and have insufficient time to gather necessary information may file a delinquent FBAR by September 23 with an attached explanation detailing the reason for the late filing. Question #44 followed up by reiterating that the June 30 deadline is firm for all other situations not covered in Question 43.

 

 

The voluntary disclosure process was not necessarily intended for investors and tax-exempt organizations that have properly reported all taxable income, but failed to file FBARs that were potentially required in prior years; however, the IRS appears to be making an exception for this year due to the controversy this issue has created. Investors and tax-exempt organizations who reported and paid tax on all their taxable income for prior years, but did not file FBARs, should file the delinquent FBAR reports according to the instructions and attach a statement explaining why the reports were filed late. If copies of delinquent FBARs are sent, together with copies of tax returns for all relevant years, by September 23, 2009, the IRS should not impose a penalty for failure to file FBARs.

 

The FBAR amnesty procedures should provide an opportunity for nonfilers that cannot meet the June 30, 2009 due date for a 2008 FBAR reporting an investment in a foreign hedge fund to satisfy the filing requirement by filing the FBAR on, or before, September 23, 2009.