The fast paced evolution of digital currencies is upon us. Although the Internal Revenue Service (the “IRS”) has been increasing its focus on cryptocurrency tax reporting, the IRS and the other regulatory bodies are once again playing catch up to financial innovation. The IRS in Notice 2014-21 provided some basic guidance on tax reporting of virtual currency transactions. The Notice makes it clear that the IRS treats virtual currency as property and not as currency for income tax purposes. Taxpayers who receive virtual currency as payment for goods or services must, in computing gross income, include the fair market value of the virtual currency, measured in U.S. dollars, and will have gain or loss depending on the amount, if any, that the taxpayer paid for the virtual currency.
The 2017 Tax Cuts and Jobs Act removed the possibility of deferring tax on gain from swapping cryptocurrencies under the Section 1031 like-kind exchange rules. H.R. 3708, also introduced in 2017, would have excluded up to $600 of gain from the sale or exchange of virtual currency for other than cash, but the provision was not included in the final 2017 tax legislation.
Under the foreign bank account report (“FBAR”) rules, a U.S. person must file a FBAR on Financial Crimes Enforcement Network (FinCEN) Form 114 with the IRS with respect to each year in which such person held financial interests in or had signatory authority over offshore financial accounts with a value exceeding $10,000. Any U.S. person who willfully fails to file the FBAR form may be assessed penalties in the amount of the greater of $100,000 or 50% of the total balance in the undisclosed account per violation, potentially causing noncompliant individuals to owe more in penalties than was originally held in the foreign account. Non-willful violations not due to reasonable cause are subject to a $10,000 penalty per violation.
Notice 2014-21 already requires information reporting and backup withholding on payments using cryptocurrencies to the same extent as any other payment made in property.
Could the FBAR rules be extended to cryptocurrencies?
The press recently reported that an official in Treasury’s FinCEN said that he does not expect virtual currencies to be reported on FBARs, echoing an informal statement made by an IRS analyst several years ago. However, the IRS Criminal Investigation division (“CI”) considers cryptocurrencies to be an emerging threat requiring IRS CI agents to receive special training.
Uncertainty as to how to comply with the FBAR rules will continue until the IRS provides formal guidance applicable to cryptocurrencies. Cryptocurrencies are probably commodities or securities, potentially subject to regulation by the CFTC or the SEC. The types of foreign financial accounts which now must be reported on FBARs are defined broadly and include: bank accounts, such as savings, checking, certificates of deposit or any other account maintained by a financial institution or other person engaged in the banking business; securities accounts or other financial instruments accounts held with a person engaged in the business of buying, selling or trading securities; insurance policies with a cash value; commodity brokerage accounts; mutual funds; and even a money transmitter acting as an offshore intermediary between a bank account and online poker sites. Financial accounts do not include: stocks, bonds, precious metals or gems held directly by the U.S. person; or online poker sites established purely for the purpose of playing poker and not with entities that do not function like a bank or other financial institution.
The virtual currency, Bitcoin, may be stored in a digital account known as a Bitcoin wallet. When individuals place the value of their Bitcoins in an account that may be held overseas the account would be reportable under the FBAR rules if found to be a foreign financial account. Whether the account is classified as a financial account because it is maintained with a financial institution may depend on the extent to which the account or exchange functions similarly to a brokerage by offering a variety of financial services similar to banks or other financial institutions. If the Bitcoin or other cryptocurrency is placed into an anonymous offshore financial account which is knowingly not reported, the IRS may assert that the taxpayer was willful in failing to report the account.
Taxpayers holding digital currencies in foreign financial accounts should note that the annual FBAR filing date is April 15, 2018 for the 2017 calendar year. Unless the streamlined procedures, which are used only to correct non-willful failures, can apply, correcting FBAR filing failures using the offshore voluntary disclosure (“OVD”) program requires the payment of what the IRS refers to as a “miscellaneous offshore penalty” equal to 27.5% of the highest aggregate balance of offshore assets in non-complying accounts during an eight year period and the filing of eight years of amended income tax returns.
The 27.5% OVD penalty increases to 50% if the taxpayer’s OVD preclearance letter to the IRS CI is submitted after public disclosure that either: (a) the foreign financial institution where the account is held, or other facilitator, is or has been under investigation by the IRS or Department of Justice regarding offshore accounts held by U.S. persons; (b) the foreign financial institution, or other facilitator, is cooperating with the IRS or the Department of Justice in connection with offshore accounts held by U.S. persons; or (c) the foreign financial institution, or other facilitator, has been identified in a court approved issuance of a summons seeking information about U.S. taxpayers who may hold financial accounts (a “John Doe” summons). The ever-growing list of foreign financial institutions and facilitators that meet these criteria is frequently updated and published online by the IRS and can be accessed here.
Because of the volatile nature of cryptocurrency valuations, potential FBAR penalties and tax liabilities could be prohibitive for taxpayers who find themselves out of compliance. Attorneys at Seward & Kissel are prepared to advise clients on tax issues concerning reporting and regulation of cryptocurrencies, submission of FBARs, participation in the OVD program and other related issues concerning interests in offshore accounts and assets.
If you have any question regarding this memorandum or would like to further discuss issues addressed herein, please feel free to contact one of the attorneys listed below.
Our prior memoranda on blockchain and cryptocurrency developments can be accessed here:
Bitcoin Futures to Be Listed on Two Major Futures Exchanges
In Its First Action, SEC’s New Cyber Unit Alleges ICO Scam
CFTC Charges Bitcoin Ponzi Scheme
CFTC Considers Virtual Currency Derivatives to be Commodity Interests
Our prior memoranda on FBAR compliance can be accessed here:
Significant Changes to FBAR Filing Due June 30
FBAR Filing Due June 30
FBAR Deadline: June 30, 2011; Treasury Offers Limited Extensions
Treasury Finalizes FBAR Regulations
Internal Revenue Service Announces the Third Installment of Its Offshore Voluntary Disclosure Program
