Greetings once again from the PFIC headquarters of Debra Rudd.

All I would have to do is capitalize “headquarters” and I may be able to fool readers into thinking that I occupy an actual physical space that has that name. Alas, I do not have that nameplate on my office door. Yet. 🙂

But I digress.

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When must PFICs such as foreign mutual funds be reported on FBARs?

It’s that time of year again: FBAR season. If you are reading this newsletter, chances are you are at least somewhat familiar with the FBAR.

On the face of it, it is a simple form. You find the highest balance in your account, translate it to US dollars, and put it on the form along with your bank details and account number. But it is simple only in a relative sense, as compared to some of the other beastly forms we international practitioners face on a daily basis.

It is maybe not so simple in the absolute sense. As with most high-stakes reporting requirements, the FBAR has some surprises and common misconceptions that can cause difficulty even for the most experienced of tax preparers.

I received this question a while back from reader K:

Foreign mutual funds are considered financial accounts for FBAR purposes. What if the respective funds are held in a foreign brokerage account? In that case would it suffice to report the brokerage account itself without listing individual mutual funds?

K does not fail to mention there has been some disagreement on this question among professionals. Having been through many OVDP cases — where FBAR reporting is closely scrutinized — I feel relatively comfortable in this arena.

TL; DR: The answer is “yes”

A foreign mutual fund held in a foreign brokerage or investment account does not need to be separately reported on the FBAR; reporting the account that contains the fund is sufficient. If you own a foreign mutual fund directly and NOT through a foreign brokerage or investment account, the mutual fund itself must be reported on your FBAR.

FBAR primer

“FBAR” is an acronym that stands for Foreign Bank and Financial Account Report. It used to be filed on TD F 90-22.1 (the “TD” stands for Treasury Department), but is now filed on FinCEN Form 114 (“FinCEN” stands for Financial Crimes Enforcement Network). The FinCEN form must be electronically filed for the previous year by June 30 of the current year. No extensions, no exceptions. High penalties are assessed if you fail to file the form on time.

On the FBAR, you (and all other US persons) are required to report the maximum value of foreign financial accounts you own directly in your own name, jointly with any other person on earth, and accounts you have signature authority over but no financial interest in. There is also a section for entities that have a greater than 50% interest in other entities that have their own FBAR requirements to file the form on behalf of those other entities.

A “financial account” is the kind of thing you would generally expect it to be — bank accounts, securities investment accounts, and so on. The terms “signature authority” and “financial interest” also have specific definitions found in 31 C.F.R. §§ 1010.350(e) and (f). I will not go into detail about signature authority and financial interest here. Just assume for the purposes of our topic that K’s client does have financial interest in the account that holds the mutual fund.

Foreign mutual funds (and similar) must be reported on the FBAR

K began his question with the statement “Foreign mutual funds are considered financial accounts for FBAR purposes”. What is he referring to?

The Regulations specifically define “financial accounts” to include mutual funds and other funds. 31 C.F.R. § 1010.350(c)(3)(iv)(A).

The IRS has been quite clear on this stance in numerous other communications, as well. The FBAR Reference Guide (warning: PDF), for one, states that the term “financial account” includes “mutual funds or similar pooled funds (i.e., a fund that is available to the general public with a regular net asset value determination and regular redemptions)”. I assume this includes most funds that are traded on public exchanges, such as ETFs, bond funds, currency tracking funds, and so on. These funds are almost always PFICs.

So . . . K’s client has an investment account that is considered a “financial account” for FBAR purposes. He also has, inside that investment account, a mutual fund that is itself considered a “financial account” for FBAR purposes. K is asking what is actually a very common question: Do I just report the investment account itself, or do I have to separately report both the investment account and the individual assets within it that meet the definition of “financial account”?

PFICs in brokerage and investment accounts: just report the account

If you have a brokerage or investment account, you are required to report on your FBAR “the account itself . . . but the contents of the account do not have to be separately reported”. This seems logical enough. If you have to report the total value of the account plus the total value of the contents of the account, you end up overstating your total foreign financial assets.

It seems the language of this rule applies to all assets held inside a brokerage investment account, including mutual funds and anything else considered a PFIC, because otherwise you will be overstating the value of your foreign financial accounts by 1) reporting the account itself on the FBAR, and 2) separately reporting the contents of the account on the FBAR. If that were the case, the IRS could potentially use an artificially high base from which to calculate penalties for late forms. Personally, I don’t want to live in a world where FBAR reporting works that way. 🙂

If the foreign mutual fund is held in a foreign investment or brokerage account, reporting the account itself (but not the underlying assets) is sufficient to meet the FBAR requirements.

Experience tells me this works

I have had this reporting method blessed by numerous IRS auditors in the Offshore Voluntary Disclosure Program. If a mutual fund was held directly by a taxpayer, they wanted it to have a separate line on the FBAR. If held through a foreign account, they wanted the account reported on the FBAR but did not require all the underlying mutual funds to be reported separately.

Never in any of the near-100 cases I have personally worked on did an auditor require that the reporting be done differently. Until the IRS specifically states otherwise in some future communication, I think it is a solid interpretation of the rules.

Aside: Not all PFICs must be reported on the FBAR

A brief aside. Not all foreign “funds” have to be reported on the FBAR.

Things like hedge funds and private equity funds are specifically excluded from FBAR reporting, according to the handy IRS website’s Form 8938/FBAR comparison page. These funds are also almost always PFICs.

Two different types of funds, both considered PFICs, have different reporting outcomes for the FBAR. So what’s the difference? The main conceptual distinction seems to be whether your fund is available to the general public. If yes, report it on the FBAR. If not, do not report it on the FBAR. (But be cautious. The 8938 requirements do not align exactly with the FBAR requirements.)

The moral here is for investments you own directly and not in an investment account, evaluate the FBAR filing requirements asset by asset. The fact that it is a foreign fund of some kind that is a PFIC does not itself necessitate FBAR filing. For investments you hold in an investment account, you do not need to evaluate them individually because you are required to report the entire account and doing so fulfills your reporting requirement for the underlying assets.

Thank you

Thanks for reading. You know how it goes: this isn’t advice, I might be horribly wrong, and you’d be crazy to rely on this email as advice to you for your situation. Especially since it’s just a few days before the FBAR filing deadline and I may be a bit overwhelmed with all the forms I have to file really soon or Bad Things happen.

And please, as always, let me know what burning PFIC questions you have. I would love to hear them and, potentially, help find solutions to them (maybe even in the form of a future newsletter topic).