Understanding The Rules of Bitcoin Reporting for FBAR & FATCA
Bitcoin Reporting for FBAR & FATCA
As an International Tax Law Firm that focuses exclusively on IRS Offshore Voluntary Disclosure, a common question we receive is, “When is a Bitcoin Wallet Reported on an FBAR, Form 8938 or Form 8621?”
As Bitcoin (Crypto-Currency) surges in popularity, so does the importance of FBAR, FATCA and IRS reporting in general – especially in the context of International Tax Law.
As a preliminary matter, the purpose of this article is to shed some light on certain reporting requirements involving Bitcoin — namely, issues involving FBAR, FATCA, PFIC and IRS Offshore Voluntary Disclosure. It is not intended to provide a detailed history or background involving Bitcoin itself.
Background of Bitcoin
Bitcoin is a type of electronic or crypto-currency that is used in transactions primarily when an individual or business wants to maintain anonymity. While often times in years past, Bitcoin was used for illegal purposes, these days it is very acceptable currency that can be used to facilitate legal international transactions between many different countries much easier.
Bitcoin is Not only for Illegal Purchases/Exchanges
There is a misconception out there by some Attorneys/CPAs who do not understand Bitcoin, and who believe they have a higher moral compass than everyone else (Read: They Don’t). They believe that every person who uses Bitcoin must be doing so for illegal purposes. To get a better understanding of why this is so, a recent episode of American Greed had a great summary of Bitcoin involving Silk Road and the dark web.
In a nutshell, Silk Road was the equivalent of an Amazon — but for illegal narcotics. The program itself ran on the “Dark Web” (aka Under Web) which could only be accessed through certain software, and would literally layer IP addresses and electronic footprints to avoid detection by anybody. The website could not be accessed through conventional means, such as your typical Google Search.
In order to purchase the illegal narcotics, individuals used Bitcoin to facilitate the transaction. Bitcoin is anonymous, and therefore provides protection to individuals utilizing the currency, so that they cannot be detected as the purchaser of illegal narcotics.
Bitcoin Use Expands
These days, Bitcoin is utilized by various individuals worldwide for any number of different reasons.
Why? First and foremost, people enjoy anonymity and in general anonymity is not illegal. Therefore by using Bitcoin, a person can facilitate a transaction in order to avoid personal identification. While this in and of itself is not illegal, this “legal” use of Bitcoin is heading down a slippery slope by individuals who do not want to have to report foreign transactions, income, assets, accounts or investments to the IRS, by instead purchasing Bitcoin and in keeping the Bitcoin stored offshore “wallets.” Unfortunately, this can lead to IRS, FBAR and FATCA Reporting and Income Tax Evasion issues.
The IRS and Bitcoin
The IRS classifies Bitcoin as property, not currency. This is important, because when someone has property and that property is traded or exchange, the person may have what is referred to as a capital gain.
Here’s the most basic example: David purchased a house for $100,000 (non-primary residence) and sells it three years later for $125,000. David has made gain of $25,000 on the sale. As such, when David files his tax returns for the current year, he will report a $25,000 gain, usually on schedule D.
The IRS taxes capital gains at a reduced rate of either 15% or 20% depending on whether David false into the highest tax bracket or not.
Since Bitcoin is considered property, when it is exchanged or traded, there may be a gain (foregoing 1031 exchange/boot issues)
Is Bitcoin Reported on an FBAR?
That is a very good question and one that has not been concretely defined by the IRS (post-2013). With that said, it is important to understand that FBAR penalties can be severe, and can range as high as $10,000 per account, per year for somebody who was non- willful.
In other words, somebody who is unaware of the fact that they’re supposed to report a foreign account could be penalized $30,000 a year for three accounts that they did not report during the compliance period.
Moreover, if the individual also has unreported foreign income that exceeds $5,000 in a given year, the IRS has up to six years audit them instead of three – which could lead to three more years of extremely high penalties for relatively benign occurrences.
**With Bitcoin, if it was traded or exchanged and the capital gain exceeded $5000 and it was not reported on IRS tax return — it could lead to a six-year audit situation.
Bitcoin Wallet and “Account Reporting”
If you maintain your Bitcoin (and you probably do) in a virtual wallet such as Blockchain, chances are you also have an account number. Just as if you hold Stock in a trading account, the stock account must be reported, even though individually held stock does not.
It does not matter that account number is not directly linked to your personal name for FBAR purposes. Rather, if you have crypto currency such as Bitcoin, in an account that is being held in a foreign country, and the account number is linked (either directly or indirectly with you as the owner of the crypto currency), then you are going to have to most likely report this on an FBAR.
Why? Because this falls squarely into the type of reporting the IRS and US government requires. In other words, the IRS and Department of Treasury do not carve out niches such as holding electronic currency overseas in an anonymous account as non-reportable.
Otherwise, this would literally and figuratively defeat the purpose of FBAR (which is to make sure individuals who meet the basic threshold requirements report their foreign accounts to the US government)
Potential Willfulness Issue
Here’s where it can get very serious, very quickly. By placing your Bitcoin/Crypto-Currency into an anonymous account, which you are knowingly not reporting, the IRS may claim you were willful in failing to do so. Why? Because you literally have an account that is being held offshore (albeit electronically) in an anonymous account with money that you can access and use to purchase items, but you are knowingly not reporting that “money” to the IRS.
Penalties for willful violations are intense – they can reach as high as $100,000 or 50% value of the account – whichever is higher. This is notwithstanding fact that if the Bitcoin was exchanged for profit which you knowingly did not report, you may be staring down the barrel of a criminal investigation (aka Tax Fraud, Tax Evasion, Money Laundering, White Collar Crime, etc.)
FATCA Reporting of Bitcoin
In line with the above reference summary regarding FBAR, since the IRS classifies Bitcoin as property, it will need to be reported on a form 8938, since it is a specified asset. Moreover, simply because it is not in an account (presuming you are holding it outside of an electronic wallet), does not matter — because just as stock would be considered a specified asset, presumably so would Bitcoin.
***We understand that individuals will argue that certain items such as gold or silver does not need to be reported, but why would Bitcoin. The response is simple: Bitcoin is held in a “Wallet” and was initially (and to many still is) something associated with the dark web — and therefore something that the IRS may inherently believe is bad.
PFIC and Bitcoin
A PFIC is a Passive Foreign Investment Company. When it comes to Bitcoin, we have had the opportunity to work with some very highly intelligent individuals who have developed genius ways to avoid detection, while facilitating a profit with their crypto-currency.
With that said, here are two issues we have dealt with recently on this matter:
Foreign Holding Company
if a person has a holding company and the holding company has assets which include Bitcoin, the IRS may argue that because Bitcoin is not considered money, but rather property (similar to stock) that when it is being traded through this electronic wallet/holding company and generating capital gains, it meets the threshold requirements of becoming a PFIC. That is because the income being generated is still passive means, and the property (Bitcoin) will be characterized as a passive income generating asset.
Foreign Mutual Fund
The Definition of PFIC is all-encompassing and often times will include Foreign Mutual Funds. A mutual fund is essentially a managed investment. With that said, if the bitcoin is being consistently managed/traded for the sole purpose of generating capital gains or other sorts a passive income, then the IRS will make the argument that it is by default a mutual or similar trading fund which should receive PFIC treatment.
Offshore Compliance with IRS Offshore Voluntary Disclosure
The IRS offshore voluntary disclosure program is a great program for individuals to get into compliance before it is too late. With the IRS breathing down the neck of the Bitcoin industry, it is only a matter of time before the individual account holders are detected and uncovered.
While this may not lead to anything criminal, if the IRS decides to audit/examine you before you had a chance to enter the program, then you lose the opportunity to enter into IRS offshore voluntary disclosure (such as OVDP or the Streamlined Program).
Want to Learn More About Voluntary Disclosure?
Offshore Voluntary Disclosure Tax law is very complex. There are many aspects that go into any particular tax calculation, including the legal status, marital status, business status and residence status of the taxpayer.
When Do I Need to Use Voluntary Disclosure?
Voluntary Disclosure is for individuals, estates, and businesses who are out of compliance with the IRS and the Department of Treasury. What does that mean? It means that if you are required to file a U.S. tax return and you don’t do so timely, then you are out of compliance.
If the IRS discovers that you are out of compliance, you may become subject to extensive fines and penalties – ranging from a warning letter all the way up to tax liens, tax levies, seizures, and criminal investigations. To combat this, you can take the proactive approach and submit to Voluntary Disclosure.
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