The Internal Revenue’s focus on income from foreign bank and financial accounts could turn to investors in hedge funds with foreign domiciles according to recent statements by IRS officials. Given the size of penalties the Agency can assess for failure to file Form 90.22-1, Report of Foreign Bank Accounts, even in the absence of clear guidance from the IRS on hedge fund investments, taxpayers would be wise to report accounts whose aggregate value exceeds the FBAR $10,000 limit in a calendar year.
“At the end of the day, if it’s an offshore hedge fund, the U.S. investor needs to be reporting it,” says Mary Thomas, a tax accountant at Weaver & Tidwell LLP in Albuquerque, New Mexico, according to the Albuquerque Business Journal.
Hedge fund investors have not filed Form 90-22.1 as a rule, according to Joseph Fletcher, Edward L. Froelich and Arthur Man of Morrison and Foerster LLP, writing in mondaq.com. But they note new language which was added to the form itself in October 2008 referring to “accounts in which the assets are held in a commingled fund and the account owner holds an equity interest in the fund.” The authors say that “there is no definition of what type of account constitutes a ‘commingled fund,’ (other than the example of a mutual fund) but it seems clear now that the IRS believes a foreign private equity or hedge fund is a type of ‘commingled fund,’ for which FBAR reporting is required.”
In addition, taxpayers who have failed to file a Form 90-22.1 over the years, who want to participate in the Internal Revenue Service’s Voluntary Disclosure program have until September 23rd to file the delinquent forms and avoid civil penalties. Those who didn't pay taxes but come forward voluntarily won't be recommended for criminal prosecution. The original filing date was June 30. Extensions to file do not apply to Form 90-22.1.
According to a new FAQ document which appeared on the IRS web site on July 1, a taxpayer is required to file who is
a “United States person who has a financial interest in or signature authority, or other authority over any financial account in a foreign country, if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year.
The holders report their foreign accounts by completing boxes 7a and 7b on Form 1040 Schedule B and completing Form TD F 90-22.1.
Failure to report foreign source income, even a small amount, can be subject to penalties of $10,000 a year. The IRS’ FAQ acknowledges that it is possible to assert civil penalties for FBAR violations in amounts that exceed the balance in the foreign financial account.
Authorities differ about whether or not taxpayers may challenge FBAR penalties. “Voluntary Disclosures: Questions and Answers”, a document published by the IRS in May, provides detailed information about potential penalties that nonfilers can face if they are caught. Among several important clarifications provided in this FAQ document, according to Jim Mastracchio, a partner with Caplin & Drysdale LLP, tax attorneys in Washington, DC, "the most significant is the IRS' recognition that taxpayers can challenge the 20 percent penalty associated with delinquent FBAR filings, provided the facts and circumstances support the taxpayer's position." The IRS also states that it may not be able to look back more than three years to calculate past due taxes.
A recent article in the Wall Street Journal article seems to contradict this view. It says that FBAR penalties may not be challenged in a Tax Court. It also says that taxpayer information on Form 90-22.1 is not protected by IRS privacy rules.
Some individuals who have confessed to nonpayment under the Voluntary Disclosure program have been asked for face-to-face meetings by the IRS, according to the Journal report, where some tax advisers say “IRS agents are using a prepared list of 30 questions to grill taxpayers.” One goal of the questions seems to be to find out “who is promoting these offshore accounts. Among other things, they are asked who told them about the foreign bank account or investment, who helped open it, and whether there is a credit card tied to the accounts.”
The IRS says there is no standard list of questions.