Limited partners and individual investors in private equity funds and hedge funds may remember last year’s FBAR scare: IRS officials created confusion as to whether investors in offshore private equity and hedge funds would have to file a Report of Foreign Bank and Financial Accounts (FBAR) for tax purposes. Last week the Treasury backed away from those statements, allowing investors to breathe a sigh of relief.
I spoke with Seth Entin, a tax lawyer at Greenberg Traurig, on the topic.
peHUB: So what exactly is FBAR?
Entin: It’s a one or two page disclosure form administered by the IRS. It’s used to disclose if you have an ownership in an offshore financial account. It’s designed not just for tax purposes but also to detect money laundering and other crimes as well.
Before the IRS said everyone needed to file one, how was it used?
People used to invest in foreign hedge and PE funds and didn’t think they had to file these. So most people who invested in foreign funds never filed it. Then a few statements were made by IRS officials that said if a US investor owns an interest in a foreign PE or hedge fund, you have to put it on an FBAR, not only for this year, but for all prior years.
And what happened then?
There was a backlash. The IRS extended the deadline for this reporting because of the uproar. At the same time, they decided to revisit it.
Why the backlash? What are the concerns from taxpayers and advisors?
Not wanting to get fined. Failure to comply carries a steep fine, especially for people over the years who weren’t doing the filing. There would have been a lot of cleanup work for US investors. It takes a big compliance burden off of US investors.
But this week they came out with proposed regulations that say for right now, under the current law, you don’t have to file it. So we’re back to where we were.
So it was all a misunderstanding over interpretation?
Not exactly. There was uncertainty, because the IRS made an argument that it was reported on, and then they back tracked.
Why did the IRS back track?
It was two things. People in the industry made some respectable arguments that under the technical rules, reporting shouldn’t be required. People brought to the attention of IRS some decent arguments why it shouldn’t be required. And also, the IRS may have been colored by the practical difficulties imposed on people with these types of investments. While they may reconsider it in the future, for now it’s not required.
What does mean for investors in PE funds?
They can sleep better at night if they weren’t filing an FBAR, but they should be aware that there are proposals in Congress about changing things.