Over the course of the last several years, Bitcoin has moved from something of a promising curiosity to a technology that many see as applicable to an array of industries and endeavors. At the heart of Bitcoin and similar digital currencies, such as DogeCoin and Etherium, is a concept known as the block chain. The block chain is essentially a digital equivalent of a public ledger. The public ledger contains a record of all transactions carried out within this blockchain. Computers that contribute resources to the blockchain continually check the propriety of transactions by computing hash values. The open, public, and verifiable nature of a blockchain means that future applications could range from financial and banking transactions at major international financial institutions to recording deeds and other public or private records.
However, the blockchain and, by extension, Bitcoin are still primarily a means of storing value digitally. As an application of the blockchain that straddles the line between currency and property, the use of Bitcoin can have tax and tax reporting impacts. Taxpayers who mine Bitcoin, hold or conduct transactions in Bitcoin should consult with a tax professional to avoid potentially costly mistakes regarding failures to report Bitcoin assets.
The obligation to file a Report of Foreign Bank Account (FBAR) is found in the Bank Secrecy Act. While the duty to file FBAR has long been enshrined in U.S. law, the obligation was largely ignored for the early portion of its existence. However, in the mid-2000s, Congress amended the Bank Secrecy Act to include penalties for non-compliance. When taxpayers fail to report FBAR – even accidentally – they are subject to a potential penalty of up to $10,000 per a violation. When IRS agents believe that noncompliance was willful in nature, penalties escalate to the greater of $100,000 or 50 percent of the account balance. The duty to file FBAR exists any time the aggregate balance in covered foreign accounts exceeds $10,000.
The duty to file FATCA was established through the Foreign Account Tax Compliance Act passed by Congress in 2010. Penalties are also harsh for failures to comply with this informational reporting law. Unlike FBAR, there is no bright-line rule setting forth when a taxpayer must file. Rather, a taxpayer must first determine his or her tax filing status and residency. Depending on these factors, the taxpayer will be able to hold different amounts of foreign assets before a duty to report is triggered. In general, married taxpayers filing jointly and living abroad can control the most assets before they are required to report. In contrast, sole filers who live in the United States can hold the least foreign assets before he or she incurs an obligation to report.
Taxpayers can be obligated to report a single account on both FBAR and FATCA. Reporting an account under one regime does not satisfy the independent duty to report under other offshore disclosure laws. FBAR obligations are properly reported through a timely filing of FinCEN Form 114. FATCA obligations are satisfied by a timely filing of IRS Form 8938.
While we characterize Bitcoin as “digital currency” above and this is the fashion that people are most accustomed to thinking about Bitcoin, this does not comport with how the IRS views Bitcoin. In IRS Notice 2014-21, the IRS indicated that it was aware of “virtual currencies” and the ways in which people typically utilized these currencies. The IRS announced that despite people’s propensity to treat Bitcoin as a currency in certain scenarios, Bitcoin would be treated as property for federal tax purposes.
To understand what Bitcoin has to do with foreign account reporting obligations, first, consider the different ways one can store Bitcoin. A user of the currency could print out his or her full or partial bitcoin and carry it around like cash in his or her wallet or purse. The user could also store his or her Bitcoins in a digital account known as a Bitcoin wallet.
This distinction is important because hard currency, real estate, precious metals held directly, personal property, and certain covered benefits programs are not reportable for purposes of FBAR or FATCA. However, once these assets are placed in a foreign financial account, they become reportable for purposes of FBAR and FATCA. Since users of Bitcoin can place the value of their Bitcoins in an account that may be held overseas, this would seem to be an area of some concern.
Second, also consider the tax nature of property versus that of currency. When an item is considered property for tax purposes the concepts of capital gains and capital loss must be accounted for. When Bitcoin gains in value during the time a person holds it, the gain in value must be computed and reported. Typically, there will also be tax due on the gains in the form of the capital gains tax.
In light of the potential penalties that can be imposed for FBAR and FATCA compliance failures, the IRS’s guidance on the issue cannot be described as anything but anemic and inviting tax controversy. In 2014, Rod Lundquist, a senior program analyst for the Small Business/Self-Employed Division indicated that the IRS would not require Bitcoin to be reported as part of FBAR. He elaborated by adding that that “FinCEN has said that virtual currency is not going to be reportable on the FBAR, at least for this filing season [emphasis added].” The IRS later clarified this statement in response to a reporter’s inquiry. It clarified that virtual currency accounts also fell under the non-reportable guidance.
Despite the unofficial nature of this guidance, this is still the only statement taxpayers have to guide their offshore account reporting. And this statement was explicitly limited to the context of a single tax filing year.
Recent enforcement actions taken by the IRS may suggest the possibility that the IRS is reconsidering its approach to Bitcoin and foreign account informational disclosures. In November 2016, the IRS filed a John Doe summons seeking information relating to U.S. account holders who had Coinbase Bitcoin transactions between 2013 and 2015. The IRS’s summons states that it is “responsible for monitoring ways in which United States taxpayers evade their United States tax obligations.” In the subsequent paragraph, the IRS suggests that use of digital currencies makes the user “subject to fewer third-party reporting requirements.” This language would seem to suggest that at least some users have adopted virtual currency because they believe they can avoid reporting requirements potentially including FBAR and FATCA.
Taxpayers face an array of tough choices when it comes to protecting themselves against potential future liability because of a failure to report Bitcoin on FBAR or FATCA. Taxpayers should consult with a tax lawyer before taking any action because different circumstances may suggest or require different handling. Furthermore, taxpayers typically have different preferences when it comes to acceptable levels of risk.
At the more conservative end of the spectrum of potential approaches, taxpayers could align their handling of Bitcoin to comport with that of gold, hard currency and real estate. That is, these assets are generally not reportable for foreign account purposes when held directly, but become reportable when they are stored in a foreign financial account. Under this type of approach, a taxpayer who carries around a printed Bitcoin would not report Bitcoin for purposes of FBAR or FATCA. However, a taxpayer who has placed the value of his or her bitcoin in a virtual wallet hosted overseas should include Bitcoin for purposes of aggregation and reporting. This type of approach would, at the least, provide the taxpayer with a reasonable approach to an unsettled issue.
At the more aggressive end of the spectrum, taxpayers could continue to apply the statements made by Rod Lundquist back in 2014 to the current tax year. Taxpayers are urged to consult with a tax lawyer prior to adopting this or any other approach to satisfy FBAR or FATCA duties.
As taxpayers have become more accustomed to foreign disclosure obligations, the IRS has expanded tightened up reporting procedures. Furthermore, the IRS has stated that it reserves the right to make voluntary disclosure programs, through which taxpayers can mitigate offshore penalties and consequences, less favorable. Considering the recent enforcement actions targeting Bitcoin users for suspected tax evasion and offshore tax fraud, it is only a matter of time before the IRS further tightens the offshore tax reporting regimes. To schedule a confidential reduced rate consultation at the Los Angeles or Irvine Tax Law Offices of David W. Klasing, please call 1-800-681-1295 or book online today.