Foreign bank account reports (FBARs) and the 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI)

Foreign bank account reports (FBARs) for 2010 are due on June 30, 2011 (and no extension is available). Recent guidance provides insight into who is required to file an FBAR and what is considered to be a “foreign financial account” that must be reported on an FBAR. In addition, the IRS recently announced a new offshore voluntary disclosure initiative that would allow U.S. persons to report unreported foreign financial accounts and other foreign assets to the IRS and obtain a significant reduction in civil penalties as well as in the risk of criminal prosecution.

FinCEN Final Regulations – Applicable to FBARs for 2010 and Subsequent Years

On February 24, 2011, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) published final regulations related to FBAR filing requirements for foreign financial accounts maintained in calendar year 2010 (required to be filed by June 30, 2011) and thereafter. Revised Form FBAR instructions are expected to be published in the very near future in time for the June 30, 2011, due date.

The final FinCEN regulations limit the FBAR filing requirement to U.S. citizens, U.S. residents, and domestic entities. This
limitation is important because in FBAR instructions issued in 2008 the IRS had extended the definition of “U.S. person” required to file an FBAR to include non-U.S. persons “in and doing business in the United States.” However, for
2008 and 2009 FBARs (due in June 2009 and 2010, respectively), the IRS allowed taxpayers to disregard its extended definition of U.S. person. For 2010 and subsequent years, the final regulations make clear that only U.S. citizens,
U.S. residents, and domestic entities are required to file an FBAR.

The new rules include a revised definition of “signature or other authority” of an individual over a foreign financial account. Under these new rules, such signature or other authority will exist only if the foreign financial institution will act on a direct communication from such individual regarding the disposition of assets in the account. The final regulations retain the general rule, with certain exceptions, that U.S. persons with such signature or other authority over, but no financial interest in, a foreign financial account must file an FBAR reporting such account. The IRS previously extended to June 30, 2011, the FBAR filing due date for such persons for 2009 and earlier calendar years. (Notice 2009-62 (8/7/09), Notice 2010-23 (2/26/2010)). As a result, those persons with signature or other authority over a foreign financial account likely will have to file FBARs for 2010, as well as for prior years, by June 30, 2011.

The new rules also clarify that, generally, an account is not foreign, and therefore is not required to be reported on an FBAR, if the account is maintained with a financial institution in the United States. For example, using a U.S. bank as a global custodian for international assets does not trigger the filing requirements, as long as the custodial services customer
cannot directly access his foreign assets maintained in a foreign institution.

A foreign mutual fund or similar pooled fund is treated as a reportable “foreign commingled account” for FBAR purposes. The final rules clarify that the definition of “mutual fund” includes a requirement that the shares be available to the general public, as well as having a regular net asset value determination and regular redemption feature. FinCEN has reserved
on the treatment of investment companies other than mutual funds or similar pooled funds (e.g., foreign hedge funds and private equity funds) as reportable commingled funds. Until further guidance is provided, interests in investment
companies other than mutual funds or similar pooled funds should not have to be reported on an FBAR for 2010 and later years.

2011 Offshore Voluntary Disclosure Initiative – August 31, 2011 Deadline

On February 8, 2011, the IRS announced a new voluntary disclosure program for U.S. persons with unreported foreign financial accounts and other foreign assets. The 2011 Offshore Voluntary Disclosure Initiative (2011 OVDI) is based on a similar voluntary disclosure program that ran through October 2009 and generated over 15,000 voluntary disclosures.

Under the 2011 OVDI, eligible taxpayers have until August 31, 2011, to file all original and/or amended tax returns and include payment for (or good faith arrangements to pay) taxes, interest and accuracy-related penalties for the years from 2003 to 2010 for which there are unreported foreign accounts or assets. Those taxpayers who make the voluntary disclosure and fully cooperate with the IRS in the process generally should avoid the risk of criminal prosecution. Those taxpayers who currently are under civil examination or criminal investigation by the IRS are not eligible for the 2011 OVDI.

The penalty framework under the 2011 OVDI requires to be paid a penalty equal to 25% of the value of the previously unreported foreign accounts and assets held in the year with the highest aggregate value of such foreign accounts and assets during the eight year period from 2003 through 2010. (It appears that the 2010 year is included in the penalty calculation even if the 2010 FBAR and/or other information returns are timely filed in 2011.) This 25% penalty is higher than the 20% penalty that applied to those taxpayers that filed under the 2009 disclosure program. Participants in the
2011 OVDI also must pay back-taxes and interest for any year from 2003 to 2010 for which tax is due, as well as paying any applicable accuracy-related and/or delinquency penalties. The 2011 OVDI provides for reduced penalties of 5% and
12.5% in limited circumstances.

Taxpayers who came in under the 2009 voluntary disclosure program may apply for a review if their penalty would have been lower under the 2011 OVDI. In addition, those taxpayers who voluntarily disclosed their foreign accounts and assets after the 2009 program ended in “quiet disclosures” will be eligible for the 2011 OVDI, so long as they follow the procedures, and meet the August 31, 2011, deadline, thereunder.

Taxpayers who reported and paid tax on all their taxable income for prior years but did not file FBARs or other information returns related to reporting foreign income and/or assets (e.g., Form 3520 and Form 5471) can file their delinquent returns outside the 2011 OVDI, without being subject to a penalty for the failure to file if such returns are filed by
August 31, 2011. However, taxpayers may need to be cautious about relying on this “safe harbor” rule. If the taxpayer files the returns outside the 2011 OVDI, and, on a later audit, the IRS were to discover an unreported tax liability in
a prior year, while not entirely clear, it is possible that the taxpayer may be liable for the maximum penalties that can be imposed on late FBARs or other information returns rather than the reduced 25% penalty under the 2011 OVDI.

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