Editor: Please tell us about your background and practice .
Nussbaum: As a partner in the Tax Department and as a member of the Private Investment Funds Group, my practice concentrates on planning for and structuring private investment funds and also representing investors in those funds. I also have considerable experience in structuring taxable and tax-free mergers and acquisitions, stock and debt offerings and real estate transactions.
Editor: We have read a lot recently about U.S. persons hiding income in offshore accounts. What is the FBAR and how does it fit in?
Nussbaum: The FBAR stands for the Report of Foreign Bank and Financial Accounts, or Form TD F 90-22.1. The form is required to be filed by each U.S. person who has a financial interest in, or signature or other authority over, foreign financial accounts that have an aggregate value exceeding $10,000 at any time during the calendar year. One of the purposes of the form when it was initally created was to track unreported income.
Editor: What happens if you don't file an FBAR?
Nussbaum: The Internal Revenue Service (the "IRS") may impose steep penalties for failure to file an FBAR, including a penalty of up to $10,000 if the failure was non-willful. Willful failure to file an FBAR is subject to a penalty equal to the greater of $100,000 or 50 percent of the highest amount in the foreign account during the reportable calendar year. These penalties, compounded with interest, can essentially wipe out a taxpayer's foreign assets. Additionally, taxpayers could be subject to criminal penalties and imprisonment.
Editor: How is the FBAR different from other tax returns?
Nussbaum: The FBAR is filed separately from your tax return. FBARs for calendar year 2010 must be received by the Treasury Department no later than June 30. A taxpayer cannot rely on a postmark date, and the form currently cannot be submitted electronically. It is best to file either by registered mail (return receipt requested) or by UPS, Federal Express or similar service.
Editor: If the FBAR is not due until June 30, why is it important for people to begin focusing on the form now?
Nussbaum: Besides giving people time to gather the relevant information to complete an FBAR, it is important to start focusing now in order for a taxpayer to be able to respond to any FBAR-related questions on the taxpayer's personal, corporate or other federal income tax return (such as Form 1040, Schedule B, Question 7 and Form 1120, Schedule N, Question 6).
Editor: So let's get back to the details of the reporting requirement. What exactly is a foreign financial account?
Nussbaum: The Treasury Department's Financial Crimes Enforcement Network recently released final regulations that make certain clarifications and modifications to the reporting requirements, which are effective for calendar year 2010 FBARs. Two of these clarifications relate to the definition of "foreign." First, an account is not a foreign account under the FBAR rules if it is maintained in the United States, even if the account contains foreign assets. Second, a taxpayer is not required to file an FBAR with respect to an "omnibus" account that pools assets outside of the United States if the taxpayer can only access the account holdings through a domestic financial institution.
Editor: When were the final regulations issued?
Nussbaum: The final regulations were issued on February 24, 2011.
Editor: Financial accounts presumably would include bank and securities accounts. What else would be picked up?
Nussbaum: Like many of the FBAR-related definitions, the definition of financial account is very broad. It also would pick up foreign mutual funds and similar pooled vehicles. However, the final regulations do clarify that a foreign mutual fund or similar pooled vehicle is a reportable account only if it issues shares available to the general public that have a regular net asset value determination and regular redemptions . In addition, under the final regulations, a life insurance policy or an annuity is treated as a reportable account only if it has a cash value.
Editor: Based on this definition, I would assume that interests in foreign private equity and hedge funds would not be reportable.
Nussbaum: While that is true for now, people should not yet get too excited. In the final regulations, the Treasury Department has continued to reserve the right to issue regulations in the future on these funds. The final regulations do not provide any guidance on when this issue will be resolved.
The reason why there has been so much focus on this area is that in October 2008 the IRS added the parenthetical "(including mutual funds)" to the definition of financial account. Later, in March 2009, in its Frequently Asked Questions, the IRS stated that a foreign financial account includes an interest in a "mutual fund" or a "unit trust." Even with those additions, most people did not think that the definition of foreign financial account included an interest in a hedge fund or private equity fund. However, in a June 2009 teleconference, IRS panelists stated that the term "financial account" includes interests in hedge funds that function like mutual funds. You can imagine the reaction of practitioners to this information. The IRS later issued guidance that initially extended the due date for this filing to September 23, 2009 and then extended it again to June 30, 2010 for those U.S. persons who had signature or other authority over or a financial interest in an offshore hedge fund or private equity fund. Then last year, the IRS issued a notice that indicated that for 2009 and earlier years, the definition of foreign financial accounts would not include hedge funds and other similar types of investment funds. However, at the same time, the Treasury Department issued proposed regulations that, similar to the final regulations, reserved the right to issue regulations in the future on these funds. Therefore, taxpayers who have signature or other authority over or hold financial interests in these types of funds should retain any relevant information for 2010 and later years so that they are prepared in the event that the Treasury Department decides to promulgate regulations in the future.
Editor: Let's move on to discuss when a person would be viewed as having a financial interest. Are the rules broad here as well?
Nussbaum: The definition is so broad that often multiple taxpayers are required to report the same account. For example, a financial interest includes being the owner of record of, or having legal title to, an account, even if acting as agent, nominee or in some other capacity on behalf of a U.S. person. A U.S. person also has a financial interest in an account held by a corporation or partnership of which that person owns, directly or indirectly, more than 50 percent. Further, a U.S. person has a financial interest in an account held by a trust (i) if that person is the trust's grantor and the trust grantor has an ownership interest in the account for federal income tax purposes (i.e., the trust is a grantor trust), or (ii) in which that person either has a present beneficial interest in more than 50 percent of the assets or from which that person receives more than 50 percent of the trust's current income. There is also an anti-abuse rule that applies if a U.S. person causes an entity to be created for a purpose of evading the FBAR requirements.
Editor: I understand that the final regulations made a significant change to the definition of signature or other authority.
Nussbaum: Yes - signature or other authority has been redefined to include the authority of an individual (alone or in conjunction with other individuals) to control the disposition of money or other property in the account by direct communication (whether in writing or otherwise) to the person with whom the account is maintained. The preamble to the final regulations also clarifies that the definition of signature authority applies only to individuals.
As you may be aware, the filing requirement for anyone with signature or other authority over (but no financial interest in) a foreign financial account for calendar years 2009 and earlier was postponed to June 30, 2011 under prior IRS guidance. Although the final regulations are not technically applicable to foreign financial accounts maintained in those years, individuals making these deferred filings may rely on the final regulations to determine their FBAR filing obligations for those years.
Editor: If you have signature or other authority, are there any exceptions to reporting?
Nussbaum: There are a number of exceptions from FBAR reporting for U.S. officers or employees who have signature or other authority over foreign financial accounts of their employer, but who do not have a financial interest in the account. These exceptions are pretty limited in scope and generally apply where the employer is subject to a specific type of federal regulation (for example, by the Securities and Exchange Commission).
Editor: What special rules apply to U.S. officers or employees of both U.S. and foreign corporations with securities listed on one of the U.S. securities exchanges?
Nussbaum: There is an exception from FBAR reporting for U.S. officers or employees of entities with a class of securities or ADRs that are listed on any U.S. national securities exchange. It also applies to U.S. officers or employees of U.S. subsidiaries of such entities, but only if the subsidiary is included in the consolidated FBAR report filed by the parent. Thus, this exception is fairly limited, applying only to U.S. subsidiaries, not foreign subsidiaries, and only if the parent's consolidated FBAR includes the subsidiary, which means the exception can only apply to a subsidiary of a U.S. parent. A similar exception is for U.S officers of employees of U.S. corporations with a class of equity securities that are registered, or ADRs in respect of those securities that are registered, under Section 12(g) of the Securities Exchange Act (i.e., corporations with more than $10 million in assets and more than 500 shareholders of record). So these two exceptions are quite limited.
There was one change from the proposed regulations to the final regulations that was helpful with respect to these publicly traded entities. Under the old rules, the exception only applied if the officer or the employee received a written confirmation from the chief financial officer or similar responsible person that the corporation has reported the foreign financial account on its FBAR. The requirement of receiving this certification has been eliminated.
Editor: What actually must be reported on the FBAR?
Nussbaum: The highest balance for any accounts during that year and the address of the foreign bank or other financial institution must be reported. There is more limited reporting for those with a financial interest in, or signature or other authority over, 25 or more foreign financial accounts (but such persons may be required to provide more detailed information upon request from the Treasury Department).