FBAR Filings

The US account forms come of age

Originally published in the October 2009 issue

Under penalties of perjury, each filer of a US individual, corporate, partnership or trust tax return has answered the following question: At any time during the calendar year did you have an interest in, or a signature or other authority over, a financial account in a foreign country, such as a bank account, securities account, or other financial account?1 If the answer was “yes,” the filer was then directed to Form TD F 90-22.1 and the related instructions to understand potential reporting obligations. Before October 2008, the date the form and its instructions were updated, this additional piece of the tax compliance process seemed fairly straightforward. In 2009, however, this all changed.

As the hedge fund industry has become well aware, the above question relates to the Report of Foreign Bank and Financial Accounts, or FBAR for short. Although many potential filers associated with the hedge fund industry may have only recently learned about FBAR filing requirements through recent informal clarifications by the IRS, the question is not new. The IRS website2 makes available Form 1040 Schedule B, the schedule that contains the question on individual returns, dating back to 1980.3 In fact, the 1980 form asks almost the exact same question as the 2008 form.4 Even the instructions in the 2008 booklet that provide additional guidance as to whether a tax preparer should check yes or no to the FBAR question are almost identical to those in the 1980 instruction booklet.5

On the surface, one might wonder why FBAR has generated so much interest this year. The form itself is an information-only report, requires no tax calculation or tax payment, collects a maximum of 46 discrete data points, and includes only three pages of instruction. While at first glance this might appear to be the model of informational reporting simplicity, in actuality the lack of instructions can give rise to many unanswered, fact-specific questions. When practically applied – that is, when tax preparers attempt to fill out the form – it becomes clear that more than three pages of instructions are necessary to ensure reporting consistency.

For those in the hedge fund community, a certain level of ambiguity is tolerated – each day investment decisions are made with imperfect information. Given the severity of the penalty provisions associated with FBAR non-compliance, many fund operators have found the level of risk associated with not complying completely with FBAR requirements to be unacceptable. As detailed on the IRS website, and in FAQs published by the IRS, FBAR violations can result in the levying of both criminal and civil penalties.6 A worst-case civil penalty can equal 50% of the amount in the account at the time of the violation, which can be assessed for each year of the violation, thus resulting in a penalty that is a multiple of the actual account balance.

As is true with any aspect of a hedge fund’s operation where levels of risk become unacceptable, it is only natural that fund operators will look to mitigate, or hedge, these risks. In the case of FBAR compliance, many hedge funds adopted a view that in order to avoid “failure to file” penalties they would simply file the form under every possible applicable scenario unless a specific exclusion existed. Of the three pages of FBAR instructions, two paragraphs are dedicated to filing exceptions, and only in rare instances do aspects of hedge fund operations meet the requirement for FBAR filing exclusion.

On 7th August 2009, the IRS, recognizing that this approach by industry would result in extremely heavy and possibly inconsistent filing activity, granted administrative relief for certain filers until 30th June 2010.7 In issuing this relief, which should at least temporarily reduce the bulk of filings recently anticipated by hedge funds, the IRS has asked for comments and stated that more time is needed to properly address issues pertaining to FBAR filing requirements. In all likelihood, this will mean that affected persons will receive updated guidance before the next official FBAR due date of 30th June 2010.

It is important to note that the administrative relief recently granted is not a wholesale moratorium on FBAR filings until 2010 and that there could be many cases where past filings have been missed and are currently due. Although the report is due to be filed by 30th June of each year, a window of opportunity currently exists for certain filers who have reported all their taxable income to achieve compliance without penalty until 23rd September 2009. US persons who think they might have FBAR filing requirements should talk to their tax adviser to determine whether they are in compliance, or to verify that the extended compliance window applies to their situation.

It is often difficult to predict the form of future legislation or administrative guidance, and this is certainly the case for FBAR. As the hedge fund community awaits further official clarity in the run up to June 2010, it is useful to understand the broader context in which FBAR sits. The stated purpose of the FBAR filing is to collect information that could have a high degree of usefulness in criminal, tax, or regulatory investigations.8 For tax purposes, FBAR can be a useful tool in collecting more information about certain assets held outside the US that the IRS might otherwise not have visibility into through the various forms that taxpayers may already be filing. It is a laudable goal of the IRS to enforce tax compliance such that a level playing field exists for all persons subject to the US tax system. While there is nothing wrong with holding assets outside of the US, the IRS would like to ensure that this is not used as a mechanism for tax evasion.

On 8th July 2009, the US Treasury issued a report titled Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance,9 which the IRS posted online under their Tax Gap resource page.10 Based on 2001 tax data, and calculated in 2005, the IRS estimated the total net tax gap, defined as the total tax liability minus voluntary and enforcement collections, at $290 billion. This estimated tax gap was almost 14% of the total estimated 2001 tax liability. The IRS breaks the tax gap into three components: (1) underreporting, (2) underpayment, and (3) non-filing. By far the largest component of these three is underreporting, which the IRS describes as where a return has been filed on time, but the full tax liability has not been reported accurately. One example of underreporting would be where a taxpayer has earned income in an offshore brokerage account but has not included this as taxable income on their US tax return.

The 8th July report states that the current Administration and Congress are working closely to narrow the tax gap, and describes the primary purpose of the report as providing a comprehensive overview of efforts to close the gap. The first element the report outlines as part of a seven-part strategy involves reducing opportunities for evasion – one component of which is the Administration’s proposals and efforts to combat under-reporting of offshore income. The report goes on to state: “The President has made addressing under-reporting of income earned or held through offshore accounts or entities a top priority for his Administration.” Increased enforcement, enhanced ability to identify offshore tax schemes, and engaging in voluntary disclosure initiatives for taxpayers with undeclared offshore accounts are all listed as components of the overall strategy in closing the tax gap.

Based on the stated purpose of the FBAR filing, and the data elements it asks for, it would seem that this previously innocuous compliance exercise could play a central role in efforts to reduce a portion of the tax gap. While the IRS has granted temporary reprieve for certain filers in order to rationalise practical compliance considerations, hedge funds may want to consider making sure their annual FBAR filing, and related recordkeeping requirement, is included in their year-end reporting process.


1. See individual Form 1040, schedule B, question 7a; corporate Form 1120, schedule N, question 6a; partnership Form 1065, page 3, question 10; and trust Form 1041, page 2, question 10
2. See www.irs.gov
3. See http://www.irs.gov/pub/irs-prior/f1040sab–1980.pdf
4. See http://www.irs.gov/pub/irs-pdf/i1040sa.pdf
5. See the 1980 instructions at http://www.irs.gov/pub/irs-prior/i1040–1980.pdf, and the 2008 instructions at http://www.irs.gov/pub/irs-pdf/i1040sa.pdf
6. See the Penalty section of the Workbook on FBAR at http://www.irs.gov/businesses/small/article/0,,id=159757,00.html#penalties. Also see IRS FAQ’s at http://www.irs.gov/pub/irs-news/faqs.pdf
7. See IRS Notice 2009-62
8. See page one of the FBAR form, http://www.irs.gov/pub/irs-pdf/f90221.pdf
9. See http://www.irs.gov/pub/newsroom/tax_gap_report_-final_version.pdf
10. See http://www.irs.gov/newsroom/article/0,,id=158619,00.html


David Earley specializes in the taxation of hedge funds as part of Deloitte Tax LLP’s Hedge Fund practice. Prior to joining Deloitte, he co-founded Clipper Capital, a long short equity and derivative hedge fund. Prior to this, he was part of the tax and legal services team at PwC.