Gotten a blizzard of urgent correspondence from your accountant or investment advisor? That's because the professional community is in a panic over a potential $10,000 penalty—a penalty that can be significantly higher (up to the greater of $100,000 or 50% of the value in the account) if the Internal Revenue Service asserts that the violation is willful, with even higher criminal penalties for fraud.

June 30 was the deadline for filing an information form (Form TD F 90-22.1) concerning foreign bank and other financial accounts. Failure to file or filing incorrectly will attract that $10,000-plus penalty. This filing requirement is known in the professional community as FBAR (not to be confused with the military term FUBAR, which has some application here as well).

At stake is the formerly sleepy little foreign account filing form. This form and instructions were extensively revised late last year. The new instructions caused so much confusion that the IRS posted a series of questions and answers on its website in May.

Becoming more alarmed and confused, accountants and lawyers scheduled a national teleconference with the IRS in June. During that call, the IRS created even more consternation. This resulted in the federal agency updating the Q&A on its website. (Even this was slightly confusing as the IRS doubled the number of Q&A items, but did not change the date to reflect those subsequent changes.)

What's the Issue?

Congress and the IRS are very concerned about taxpayers hiding money offshore. This concern has escalated to a fever pitch in the past few years. Potentially millions of dollars in untaxed investment earnings are sitting in these accounts.

The information filing is for foreign financial accounts. At one time this meant bank accounts. However, the IRS expanded the definition to include other types of foreign financial accounts as well. With this proliferation of different investment accounts (especially partnership and LLC investment accounts), determining what exactly a "financial account" means has become a major issue (hence the underlying confusion). According to the IRS, even a debit card can be a foreign financial account.

Each time the advisor community has asked questions about whether different types of investment accounts were reportable, the IRS has said to report them. All this unofficial guidance is not contained in the instructions to the form—yet.

A Foreign Financial Account

The expanded definition of a foreign financial account includes, but is not limited to, any interest in an account in which assets are held in a commingled fund (including mutual funds).

Since almost all investment accounts are commingled in some way, does this mean that all investment accounts with any foreign connection must be reported? This creates a nightmare for partnership investments with multiple layers.

The IRS revelations in late June noted that hedge funds and private equity funds could be foreign financial accounts depending on where they are organized. These types of accounts were never on the IRS radar screen in prior years and are not mentioned in the instructions to the form.

Further complicating matters is the fact that all these IRS "clarifications" are coming just days before the filing deadline.

Tracking down information about these investment accounts will take some time. The good news is that investment account custodians and advisors are also on high alert for their own filing responsibility.

Who's in Charge Here?

The IRS took over enforcement of foreign account reporting in 2003 and Congress increased the penalties for violation shortly thereafter. Most notably, the IRS obtained information about U.S. taxpayers with Swiss bank accounts as part of a large-scale tax shelter bust in 2008.

Armed with this information the IRS is tracking down noncompliance with a big penalty bill in hand. The FBAR form is not filed with any IRS agency. Instead the form is sent to a Treasury office in Michigan. The form was due June 30. There is no extension and it must be received by that date.

This is unlike other tax forms, which must be mailed by the due date. The only clue about the foreign financial account filing requirement is contained at the bottom of the dividends and interest form (Schedule B) of the individual income tax return. Most tax preparers have been asking clients about foreign bank accounts since 2004 but never thought to ask about investments via partnerships.

Other Considerations

Here is a brief description of other things that you need to keep in mind.