Proposed Regulations on Foreign Financial Reporting, and What They Mean for Employee Benefit Plans and Fiduciaries

On February 26, 2010, the Financial Crimes Enforcement Network (“FinCEN”) issued proposed regulations regarding foreign bank account reporting on Form TD F 90–22.1 (the “FBAR”). As our June 2009 issue explains, employee benefit plans and those with authority over their investment activities may be required, like other investors, to file an FBAR if plan investments involve foreign bank or securities accounts. Unless an extension applies, the FBAR for calendar year 2009 must be filed with the IRS no later than June 30, 2010. The IRS has extended the due date for FBARs that report only “signature or other authority” over a foreign account, or any interest in a foreign commingled fund (other than a foreign mutual fund). That extension does not apply to all investments, and Trucker Huss has requested that FinCEN and the Internal Revenue Service (“IRS”) grant interim relief for some of our employee benefit plan clients in advance of the June 30 filing deadline.

This article discusses the proposed regulations and their implications for employee benefit plans, including what plan investments might require an FBAR filing, and who other than the plan itself may need to file an FBAR with respect to plan accounts.

General Reporting Requirements

The FBAR reports a person’s financial interest in, or signature or other authority over, one or more foreign financial accounts.

Financial Interest

With few exceptions, a person that is a citizen or resident of the United States, including a domestic trust and most other types of domestic entities, must file an FBAR for any calendar year in which that person has a “financial interest” in a foreign bank, securities or other financial account, if during the year the aggregate value of all such accounts exceeds $10,000. The FBAR is due by June 30 of the following year. A person has a financial interest in a reportable account if the person is “the owner of record or has legal title” to the account, “whether the account is maintained for his own benefit or for the benefit of others.”

A person who does not own a reportable account nonetheless has a financial interest in the account if the record owner or holder of legal title is:

  • acting as an agent, nominee, attorney or in some other capacity on behalf of the person;
  • a corporation or partnership in which the person has an ownership or voting interest of more than 50%;
  • a trust in which the person either has a beneficial interest of more than 50% or receives more than 50% of the income;
  • a trust whose settlor has an ownership interest in the trust’s assets for federal tax purposes (this generally would include a Rabbi trust); or
  • a trust established by the person, for which the person has appointed a “trust protector” (defined below) that is subject to the person’s direct or indirect instruction.

Signature Authority

A U.S. person that does not own any reportable financial accounts may nonetheless be required to file an FBAR if the person has “signature or other authority” over a reportable account. Signature or other authority includes authority to control the disposition of assets in an account, alone or in conjunction with another, by delivering written or other instructions directly to the person with whom the account is maintained.

As discussed below, it is not entirely clear how far this broad reporting obligation extends in the case of an employee benefit plan. Fortunately, IRS Notice 2010–23 (“2010–23”) provides that persons with signature authority over, but no financial interest in, a foreign financial account are not required to file an FBAR for 2010 or any prior year until June 30, 2011.

Penalties for Failure to File

Civil and criminal penalties may be imposed for failure to file an FBAR. The IRS may impose civil penalties of up to $100,000 or 50% of the value of the foreign account, in addition to criminal penalties of up to $500,000 and five years imprisonment. These penalties are discretionary, and if appropriate may be reduced or waived by the IRS.

Does My Plan Have a Reportable Financial Account?

Employee benefit plans invest plan assets in a wide variety of investments through many different types of investment vehicles. For purposes of this article, they are divided into two broad categories:

  • Shares and other similar interests in commingled investment funds
  • Separately managed investments (i.e., investments in something other than a commingled fund)

Commingled Funds

One of the most controversial issues regarding the FBAR, which is yet to be resolved, is whether and to what extent shares or other interests in foreign commingled funds should be reported on the FBAR. The proposed regulations and 2010–23 make it clear that shares of foreign mutual funds are considered “financial accounts” and must be reported on the FBAR. The jury is out with respect to hedge funds, private equity funds, and other similar pooled investment vehicles. However, 2010–23 states that pending the issuance of final regulations, foreign commingled funds other than foreign mutual funds are not reportable on the FBAR for 2009 or any prior year. Thus, interests in those foreign commingled funds need not be reported until June 30, 2011 at the earliest, which is the due date for the 2010 FBAR.

Other Investments

In addition to mutual funds, proposed regulations treat the following as “financial accounts” subject to FBAR reporting:

  • Foreign bank accounts
  • Foreign securities accounts
  • Accounts with a foreign financial agency
  • Foreign insurance policies that have a cash value
  • Foreign annuity policies
  • Foreign brokerage accounts used for commodities trading

Identifying investments that include reportable accounts is more complicated than it sounds; identifying the reportable accounts themselves is even more complicated.

ERISA requires the indicia of ownership of plan assets to be held in the U.S. For example, when a plan invests abroad in a private equity fund, the plan must hold its ownership interest in the fund in the U.S. Often such interests are held in an account with a U.S. custodial bank. Even though that account is in the U.S., the assets held within the account might be reportable on the FBAR.

In addition, plan investments may trigger an FBAR reporting obligation if the investment involves foreign securities. When a plan allocates assets for investment by a professional investment manager solely on behalf of the plan (i.e., a separately managed investment, as opposed to a commingled fund), those assets generally are placed in an account with a U.S. custodial bank. Nearly all U.S. custodial banks open sub-custody accounts with banks in foreign countries to settle foreign securities transactions. These accounts may be established with an unrelated foreign bank, or in a foreign branch of an affiliate of the U.S. custodian. Often these accounts are “omnibus” accounts held in the U.S. custodian’s name and used to settle most or all transactions that take place in a given country. In some cases, pursuant to local law, these sub-custody accounts must be established in the plan’s name. Whether a sub-custody account is in the plan’s name or not, the plan ordinarily would not have any authority to provide investment instructions directly to the foreign bank. Rather, any instructions would originate with the plan’s investment manager and be communicated to the foreign bank by the U.S. custodial bank.

Although it is not entirely clear whether sub-custody accounts are reportable on the FBAR, a cautious interpretation of the FBAR Instructions (“Instructions”) and proposed regulations counsels in favor of reporting these accounts. Under one interpretation of the Instructions and proposed regulations, a plan would be viewed as the “owner of record or holder of legal title” with respect to sub-custody accounts established in the name of the plan. “Omnibus” accounts are arguably reportable by the plan because they are held in the name of a U.S. custodian, which may be viewed as acting as the plan’s agent, nominee, or in some other capacity on behalf of the plan. TruckeröHuss has asked FinCEN and the IRS to confirm in the final regulations that sub-custody accounts are not reportable on the FBAR.

Who Must Report a Plan’s Foreign Accounts?

Because many different parties may be involved with an employee benefit plan’s investments, the broad language of the Instructions and proposed regulations could require a number of identical FBARs to be filed with respect to a single plan account. Some of these FBARs will report a “financial interest” in plan accounts, while others will report “signature or other authority” over them. A plan investment in a foreign financial account may trigger an FBAR filing by:

  • The plan trust
  • The plan sponsor
  • Members of a plan committee, such as an investment committee or administrative committee, and other officers and employees of the plan sponsor
  • The plan’s trustees
  • Others involved with the plan’s investments, such as an investment advisor, investment manager, or custodial bank.

Plan participants and beneficiaries are exempt from filing.

In addition, an individual required to file an FBAR must disclose that fact on his or her personal tax return (Form 1040).

Plan Trust

The proposed regulations confirm that employee benefit plans are not exempt from filing the FBAR. In addition, because certain trusts are considered “financial accounts”, an FBAR may be required with respect to Rabbi trusts and their investments that include reportable accounts. An FBAR filed by a plan trust would report the plan’s financial interest in any reportable accounts.

Plan Sponsor

A literal interpretation of the current Instructions may require plan sponsors to file an FBAR to report a financial interest in any foreign financial accounts held by the plan. A person is treated as having a financial interest in “a trust that was established by the person and for which the person has appointed a trust protector that is subject to the person’s direct or indirect supervision.” The term “trust protector” is not defined in the proposed regulations, however the current Instructions state that a trust protector is “a person who is responsible for monitoring the activities of a trustee, with the authority to influence the decisions of the trustee or to replace, or recommend the replacement of, the trustee.” The person or institution that serves as the plan’s named fiduciary generally will satisfy the definition of trust protector. The plan sponsor could therefore be viewed as having a financial interest in the plan’s assets because the plan sponsor established the plan trust and appointed the named fiduciary, and the named fiduciary is subject to the plan sponsor’s direct or indirect supervision. We doubt this interpretation was intended and some commenters have requested confirmation that it was not.

Committee Members and Officers and Employees of the Plan Sponsor

Each member of a plan’s administrative and investment committees may have signature or other authority over plan investments that include foreign financial accounts. In addition, officers and employees of a plan sponsor may have authority with respect to plan investments (e.g., to withdraw funds from an investment that includes foreign accounts or to transfer funds from one such investment to another). Each committee member, officer or employee with the requisite signature or other authority over the plan’s foreign financial accounts may be required to file an FBAR to report that authority, and may also be required to report on their personal income tax return that they were required to file that FBAR (see below for further discussion of the required tax return disclosure).

As noted above, persons with signature or other authority over foreign financial accounts will not be required to file an FBAR until June 30, 2011 at the earliest, and FinCEN and the IRS are considering narrowing the scope of this reporting requirement.

Plan Trustees

Plan trustees, whether institutional or individual, may have to report both a financial interest in and signature or other authority over plan accounts.

Plan trustees generally have authority to execute documents on behalf of the plan, or at least to deliver instructions to financial institutions that hold plan assets. Each plan trustee with such authority may be required to report “signature or other authority” over plan accounts, even if such authority is held by a board of trustees.

Trustees may be required to report legal title to plan accounts as a “financial interest” in those accounts. Under trust law, title to trust assets is divided: trustees hold legal title to trust assets for the benefit of trust beneficiaries, who, in turn, hold equitable or beneficial title to the trust assets. In addition, many plan trust agreements vest all right, title and interest in plan assets in the plan’s trustee or a board of trustees. Because both the Instructions and proposed regulations treat legal title to an account as a “financial interest” in the account, each plan trustee arguably must report financial interests in plan accounts on his or her own FBAR, even if the same accounts have already been reported on an FBAR filed by the plan.

Investment Professionals and Financial Institutions

Whether an investment advisor, investment manager or custodian must file an FBAR to report a financial interest in, or signature authority over, plan accounts may depend in large part on their responsibilities under the terms of an agreement and on the facts and circumstances of each case. Some cases in which an FBAR filing may be required include: an investment adviser with authority to execute investment-related documents on behalf of the plan; an investment manager with discretionary authority over the investment of plan assets; and a custodial bank or other financial institution with record ownership of a plan’s foreign accounts.

Exemption for Plan Participants and Beneficiaries

The proposed regulations confirm that participants and beneficiaries in retirement plans under Sections 401(a), 403(a) and 403(b), and IRA owners and beneficiaries, are not required to file an FBAR with respect to plan or IRA accounts. Although this exemption would not apply to other types of employee benefit plans, including non-qualified plans and voluntary employees’ beneficiary associations (“VEBAs”), the basis for requiring FBAR reporting by participants and beneficiaries, even absent an exemption, is questionable. Plan participants and beneficiaries do not hold legal title to plan assets and are not the record owners of plan assets. They hold beneficial title to plan assets. The plan or its trustees might be viewed as holding legal title to plan assets on behalf of all participants and beneficiaries, but we do not believe this is a credible argument in favor of participant and beneficiary reporting, at least with respect to non-participant directed plans. We suspect that few participant directed plans have a legitimate basis for permitting individual participants to invest in the types of investments that might trigger an FBAR reporting obligation.

Disclosure on Form 1040

Notably, if an individual is required to file an FBAR, he or she must disclose that on Schedule B of his or her personal income tax return (Form 1040). 2010-23 relieves those with signature or other authority of the obligation to make this disclosure on their 2009 and prior years’ tax returns. If trustees are required to report financial interests in plan accounts, they arguably would not be entitled to this relief and, therefore, may be required to make an FBAR-related disclosure on Form 1040.

Additional Clarification Needed

We are hopeful that FinCEN and the IRS will clarify many of the issues that have been identified in the proposed regulations and respond favorably to our comments and request for relief. In the meantime, please contact us if you have any questions regarding the FBAR reporting requirements.