BitcoinTax.info - A primer on Bitcoin Taxation in the U.S.


 

The below commentary has not been revised in light of the IRS notice

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Copyright © 2013, Tyler S. Robbins
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A Primer on Bitcoin Taxation

by Tyler S. Robbins, Esq.[i]

Introduction

 

The cryptocurrency Bitcoin has garnered significant attention from media outlets in the past few months, following the destruction of Silk Road, the influx of new Chinese buyers, and an unprecedented spike in both value (defined by reference to fiat currencies) and trading volume.  Although its primary user base over the last few years was staunch libertarians and computer whizzes, the influx of new and accessible Bitcoin brokers has allowed laypersons in most developed nations to acquire and spend the cryptocurrency.

 

Following massive volatility and gains in recent weeks, many have considered liquidating some or all of their position.  Throngs of U.S. taxpayers have taken to the Internet to learn about their tax obligation, only to be steered towards perilous advice.  While most taxpayers have an inkling that they will owe taxes to the government as a result of their Bitcoin investments, not many are aware of the potential bogeyman that lurk.  Even fewer are aware of the requirement to disclose their accounts with foreign Bitcoin brokerages and the extremely severe penalties (beginning at $10,000) that follow a failure to disclose.

 

This primer has been prepared as a practical guide for individual U.S. taxpayers speculating in Bitcoin, and as such, is not intended to be a comprehensive guide on taxation.  It is intended to give taxpayers an idea what is in store when April 15th comes around.  Miners of Bitcoin face a host of unique tax issues that are outside the scope of this discussion.  This primer does not address any issues of state or local tax law.  Lengthy discussions covering every conceivable scenario and theoretical or policy issues are omitted for the sake of brevity and ease-of-use (the author would be happy to wax poetic in a private forum).  Please submit any feedback using the contact information found at the bottom of the page.

 

You are advised to seek advice from a competent attorney or CPA before engaging in any Bitcoin related transactions or preparing your tax returns.  Please bookmark this document, as updated versions will appear at the same URL when new information becomes available. 

 

IRS Circular 230 Disclosure

 

Any tax-related opinions in any part of this document or website (including any links) are not tax advice, and were not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding tax penalties or for promoting, marketing, or recommending to another party any transaction or matter addressed herein. Any user of this website should seek the advice of a competent, independent tax professional regarding that user’s particular circumstances.  

 

The author makes no claims, promises, or warranties about the accuracy of the information provided herein.  Tax advice cannot be provided on a general basis, and must be specifically tailored for each individual by his or her particular representative.   Everything included within is the author’s opinion and not a concrete fact.

 

 

Contents

 

Introduction

Summary

Discussion

Taxable Events: Realization vs. Withdrawal

Characterization of Income from Bitcoin Sales

Speculators

Brokers

Day Traders

Calculating the Gain

Partial Sales

Multiple Purchase Dates

Tax Rates

Bitcoins Are Not Collectibles

Bitcoin Traders Are Not Entitled To Forex 40/60 Rules

Foreign Nationals Trading on U.S. Brokerages

Record Keeping

Losses and Deductions

Casualty Losses

Wash Sale Rules

Disclosure of Foreign Bank Accounts and Financial Assets

Foreign Account Tax Compliance Act (FATCA)

Bank Secrecy Act (BSA)

Penalties for Failure to Disclose under FATCA and BSA

Closing Comments

 

Summary

 

This document has been prepared as a jump-off point for the average Bitcoin speculator or trader, and is not comprehensive.  Please keep this in mind and always consult a competent CPA or tax attorney before preparing your tax returns.  This summary provides generalized information.  If you’d like a better explanation, please read the discussion.

 

This information is not, and may not be used as authority for any purpose, including avoiding penalties imposed under the United States Internal Revenue Code, or promoting, marketing or recommending to another person any tax-related matter.

 

When tax is due & calculating gains

 

First and foremost, any gains from the change in the value of Bitcoin are taxable at the moment the Bitcoin is exchanged for a fiat currency, property, or services.  The tax is due with tax returns for the year that includes the date of sale.  It does not matter that you didn’t withdraw the funds or used a foreign brokerage. 

 

Commission costs and bank wire fees from the sale of a “capital asset” should be subtracted from the proceeds in calculating gains.  Commission costs and bank wire fees from a purchase are added into the cost of the Bitcoin.  This means that transaction fees are taken into account in order to reduce taxable gain.

 

Exchanging Bitcoin into another cryptocurrency presents additional challenges briefly discussed within.

 

What Bitcoin is

 

At the current point in time, speculators and traders of Bitcoin probably should consider Bitcoin to be a capital asset.  On that assumption, these taxpayers would be entitled to preferential long-term capital gain rates (maximum of 20%) if they hold a position over one year.  Brokers and market makers hold Bitcoin as inventory, which is outside the scope of this paper.  Bitcoin gains are subject to the new 3.8% surtax on investment income for certain taxpayers making over $200,000 per year.

 

What Bitcoin is not

 

Bitcoin is not a “collectible” subject to the 28% tax rate.  Bitcoin traders are not entitled to use the day trader mark-to-market rules at the current time.  Bitcoin traders similarly not entitled to use the Forex 40/60 rules. 

 

Bitcoin is probably not a “foreign currency,” and therefore, gains are not necessarily taxed at ordinary rates (the highest rates). 

 

What is unclear?

 

Almost everything!  The IRS and Treasury have not commented on the specific application of any rules with respect to Bitcoin.  Therefore, taxpayers and professionals will need to analogize the facts of their specific situation with other sections of the tax code. 

 

The greatest uncertainty is whether Bitcoin is a currency under the tax code.  Although Bitcoin is most likely a capital asset the current time, there may be room for taxpayers to take the position it is currency. 

 

If considered a currency, all gain will be ordinary, taxed at the highest rates.  The benefit to this treatment is that there is an exemption of $200 in gains per transaction, only on personal transactions (not investments and not for-profit transactions).  This covers the gain realized on purchasing a cup of coffee with appreciated Bitcoin that taxpayers are otherwise required to account for.  Note that taxpayers asserting Bitcoin is a currency may not simultaneously claim preferential tax rates on long-term gains.  Taxpayers should be aware that even if they assert Bitcoin is a currency, the Forex 40/60 rules still do not apply.

 

Taxpayers must keep informed of developments on this topic before preparing returns.  It is possible that the IRS will issue guidance before then.

 


 

Other important rules

 

Taxpayers must be aware of the accounting required to figure out the appropriate gains in the case of partial sales and lots bought and sold on multiple dates.

 

Taxpayers may be able to establish their purchase date via the block chain, or other creative electronic methods.  This may be important if seeking long-term capital gains rates.

 

If Bitcoin is stolen, or private keys are lost, the standard rules of deducting casualty losses should apply.  

 

Foreign nationals are most likely exempt from U.S. taxes on any gains they earn while trading on a U.S.-based Bitcoin brokerage.

 

Mandatory disclosure of foreign accounts

 

The most important issue for Bitcoin traders to discuss with their advisors is the disclosure of foreign assets under FATCA and BSA.  Bitcoin held in a wallet is probably not subject to disclosure.  But, Bitcoin or cash held in a foreign brokerages’ custodial account is likely subject to disclosure if the value exceeds $10,000 at any point during the year.

 

A custodial account is an account established set up for the benefit of the taxpayer, but held and maintained by the brokerage.  This type of account arises when the taxpayer does not hold the private keys and must submit a request to the brokerage release coin.  A similar issue arises with deposit accounts that when the taxpayer converts Bitcoin into fiat currency and holds it in the brokerage’s account. 

 

If you think this might apply, you are encouraged to read the discussion and consult an attorney.  Taxpayers are urged to be conservative and err on the side of disclosure.  Penalties for failure to disclose foreign assets start at $10,000 per account, per year, and grow rapidly.

 

Discussion

Taxable Events: Realization vs. Withdrawal

 

The first and perhaps most important question to the Bitcoin trader is not how much tax is due, but when the tax is due.  The federal income tax relies on the theory of "realization" in order to determine in what time period income is taxable.  An amount is "realized" when money (or property) is exchanged for another property.[1]  An amount is also “realized” in a barter transaction, when the holder exchanges Bitcoin for services or other property.[2]

 

In short, this means that any gains or losses generated by any transactions trigger a tax at the time of the sale (or barter), rather than when the proceeds are withdrawn from the brokerage or bank.[3]  Of course, the tax is not due and payable until the appropriate deadline for tax returns, although you may owe estimated tax payments.

 

Using a foreign brokerage or bank account does not affect the timing of gains, because U.S. citizens and resident aliens are subject to tax on all their income worldwide regardless when it is received.[4]

 

Example 1:       Ben Bernanke purchases 1 BTC (one of the several currency codes for Bitcoin) for $300 on January 1, 2013 from MtGox, funded by his Japanese bank account.  On December 15, 2013, Ben sells 1 BTC for $350, but does not withdraw the funds from his brokerage account.  On December 20, 2013, Ben purchases 1 BTC for $350.  Ben does not sell his remaining Bitcoin before the end of the year.   When the ball drops, 1 BTC is valued at $300.

 

Conclusion:     Ben has realized proceeds of $350 and gains of $50 that must be reported on his tax return for 2013, even though he never withdrew the funds, conducted the transaction abroad, and has received no economic benefit.

 

Example 2:       Satoshi Nakamoto purchases 1 BTC for $100 on April 1, 2013.  A day later, 1 BTC is valued at $200.  Later that day, when the value of 1 BTC has not increased, Satoshi exchanges his 1 BTC for a detailing job on his car that has a fair market value of $300.

 

Conclusion:     Satoshi has realized $300 of proceeds and $200 of gains that must be reported on his tax return for 2013.

 

In the case of sales resulting in the realization of a loss, this rule may be modified by the wash sale provisions, described below.

 

Converting Bitcoin into another cryptocurrency is an interesting scenario.  On one hand, the taxpayer clearly has a realization event.  Bitcoin is exchanged for a different property, so gains have been realized.  On the other hand, it could be possible that a so-called “Section 1031 exchange” has occurred.[5] 

 

Section 1031 exchanges allow taxpayers to defer gain recognition by exchanging a property for another “like-kind” property.  The rules have several layers of complication, beginning with whether one believes two cryptocurrencies are of a “like-kind.”  It is therefore very unclear if these provisions would apply.  A second matter and recurring themes is whether Bitcoin is considered a currency, because it is clear is that Section 1031 exchanges do not apply to exchanges of different currencies.[6]  Taxpayers should discuss the availability of these provisions with their CPA. 

 

Characterization of Income from Bitcoin Sales

 

Perhaps the most contentious argument surrounding the taxation of Bitcoin is its “character.”  The character of an asset is what dictates its tax treatment.  Bitcoin can have one of three potential characters: inventory, capital assets, or currency.  Inventory is specific to brokers and market makers, and outside the scope of this article.

 

Capital asset treatment is more favorable if it is held over one year, because the taxpayer is entitled to preferential tax rates, whereas currency status requires that any gain or loss is taxed at ordinary (the highest) tax rates.[7]  If the taxpayer holds Bitcoin under one year, the character may not be important. 

 

At the current point in time, it is likely that Bitcoin is seen as a capital asset, not a currency.  A capital asset is defined by what it is not.  A capital asset is not inventory or property used in a trade or business.[8]  Most investments are traditionally considered to be capital assets.  The main (and perhaps, only) benefit of currency treatment is that small personal gains under $200 per incident are exempt from tax.[9]  This does not include investment gains or any gains made in a for-profit transaction.  Rather, this covers the casual conversion of a foreign currency into for example, a cup of coffee. 

 

Imagine a taxpayer flies to Paris and converts $1 to €1.  The next day, the Euro’s value against the Dollar increases by 50% and that single Euro is worth $1.50.  The taxpayer then buys a coffee with the full amount.  The taxpayer has clearly realized a gain of $0.50.  But, these minimal gains are the type exempted under the $200 per incident rule.  It should be obvious that this rule must apply in the future if Bitcoin is to receive widespread usage.  Otherwise, spending Bitcoin would be an accounting nightmare. 

 

Although enthusiasts insist Bitcoin is a currency, the IRS has not opined on how they wish to treat such transactions.  It is important to note that different definitions apply for different purposes of federal law.  For example, despite both offices being established under the Department of Treasury, FinCEN might consider Bitcoin a currency in order to properly regulate it under the Bank Secrecy Act, but the IRS may not.  Therefore, it is important not to assume that Bitcoin is taxed one way or the other because of something in the news.  It is notable that under the currency provisions, a currency need not be "foreign," but rather, the "non-functional," or non-primary currency of the taxpayer.[10]  Therefore, it is certainly plausible Bitcoin could be considered currency.

 

For the time being, the author does not believe that Bitcoin should be considered a currency, and that ordinary tax rates and the personal spending exemption do not apply.[11]  However, in the coming weeks, the IRS may exercise its regulatory authority and declare Bitcoin to be such. But, there is enough wiggle room to make out a case for either.

 

Note that if a taxpayer takes the position Bitcoin is a currency, he may not claim that he is entitled to capital gains treatment on his gains.  Conversely, if the taxpayer takes the position that gains on Bitcoin are capital, he must report all income from expenditures made in Bitcoin, even those under the $200 threshold. Taxpayers should consider disclosing questionable positions on tax returns.  Taxpayers should be aware that even if they assert Bitcoin is a currency, the Forex 40/60 rules still do not apply (discussed below).

 

Speculators

 

Speculators hold Bitcoin hoping to profit from an increase in price, and may engage in casual trades.  Speculators most likely Bitcoin as a capital asset (an investment) as described above.  If you are reading this, you are most likely a speculator.

 

Brokers

 

Brokers and market makers hold Bitcoin as inventory.  As such, they may not treat Bitcoin a capital asset by definition.[12]  Instead, it is an ordinary asset.  Inventory is subject to uniform capitalization rules and certain accounting rules, all of which are not discussed within. 

Day Traders

 

The mark-to-market accounting regime is not available to day traders of Bitcoins, because the Code specifically outlines certain securities that qualify.[13]  It very well could be within IRS’s regulatory authority to extend this treatment to Bitcoin, but this could take years or even decades to come to fruition.  As a result of Bitcoin not qualifying as a security, the presumption of ordinary income is ineffective.[14]  This means that in the off chance a day trader holds a position over a year, he will not be subject to heightened documentation rules in order to claim preferential tax rates. 

 

Day traders can quietly celebrate, because the rules for deductions apply to all income producing investment activities the same as they do for stocks.  If the trading is tantamount to a business, ordinary and necessary deductions may be directly allowed with no limitation, such as the itemized deduction floor or AMT.  But, these individuals should be aware that the documentation requirements and courts are heavily weighted against allowing trading to constitute a business.  Most taxpayers take their investment expenses as itemized deductions.

Calculating the Gain

 

This is among the easiest concepts discussed.  Taxable gain is equal to the “amount realized” (that is, the net cash received or fair market value of the barter exchange), less the “basis” of the Bitcoin.[15]  Basis is equal original cost and any acquisition costs.  Acquisition costs should include bank wire fees and Bitcoin broker commissions.[16]

 

Example 3:       Barack Obama purchases 1 BTC for $300, plus $1 in wire transfer fees, and $10 in commission.  Barack sells 1 BTC for $400 one week later, and pays $1 in wire transfer fees and $15 in commission.

 

Conclusion:     Barack’s amount realized is $384 ($400 - $15 - $1), and his adjusted basis is $311 ($300 + $10 + $1).  Barack’s taxable gain is $73.

 


Partial Sales

 

Partial sales complicate the determination of gains.  Stock basis must be proportionally allocated among the lot that is being divided up.  There is no reason to think Bitcoin would eventually be treated differently.

 

Example 4:       Edward Snowden purchases 1 BTC for $100 on January 1, 2013.  On March 1, 2013, Edward sells 0.5 BTC for $75.  Edward’s basis in the sold lot is $50 ($100 x 0.5).  At the end of the year, Edward still holds 0.5 BTC. 

 

Conclusion:     For the year 2013, Edward must report $25 of gain ($75 - $50).  When Edward sells the remaining 0.5 BTC, his basis will be equal to $50.

 

Multiple Purchase Dates

 

Buying and selling without completely closing out a position can also complicate matters, especially if a position is held past the end of the year.  The default rule is that the oldest asset is considered sold first (first in, first out, or FIFO).  Special rules exist for trades in securities, but not for other assets.  Experts agree that the same principles should apply for other types of assets, although no legislation actually exists.[17]  Until otherwise stated, it seems appropriate to follow the same rules as securities, and to keep accurate records.

 

In some situations, a taxpayer can also choose to sell his newest assets first (last in, first out, or LIFO), or average the cost of his holdings.  Taxpayers may be able to use these rules to strategically plan to recognize the smallest amount of gain before the year ends.  For more information, see IRS Publication 550 (page 46). 

 

Note that in order to take advantage of LIFO, taxpayers must be able to specifically identify which Bitcoin is oldest.  This may be impossible because there is no actual “coin,” and Bitcoins are recorded as a register tied to an address.  Taxpayers planning on specifically identifying Bitcoin should keep each and every purchase in a separate address, and maintain records indicating when the address was funded.  Once the funds are commingled into a single address or brokerage account, specific identification is impossible.

 

Tax Rates

 

As most readers are aware, capital gains are taxed at favorable rates if the property is “long-term,” or, held over one year.  Note that requirement is more than one year, not equal to one year.[18]  Capital gains and losses, both short term and long term, are netted against each other when tax returns are prepared.  If this results in a long-term capital gain, the taxpayer is entitled to preferential rates.

 

In 2013, those rates are 0%, 15%, and 20%, and depend on the taxpayer’s ordinary income bracket.  In addition, certain taxpayers earning over $200,000 must pay an additional 3.8% surtax on net investment income under the Affordable Care Act, in order to fund “Obamacare.”[19]

 

All other income from the sale or barter of Bitcoin, such as short-term capital gains, is taxed at ordinary tax rates, plus the 3.8% surtax, if applicable.  If Bitcoin is treated as a currency, gains would be taxed at ordinary rates.[20]

 

 

Bitcoin is Not a Collectible

 

It is also possible that Bitcoin may eventually be subject to tax as a “collectible.”  Collectibles are subject to a capital gain tax rate of 28%.  At the current time, collectibles include works of art, rugs or antiques, metals or gems, stamps or coins, alcoholic beverages, and any other item of tangible property the IRS declares to be such.[21]

 

It follows that Bitcoin is simply not a collectible under the current law for at least two reasons.  First, Bitcoin has not been declared a collectible by Congress.  Second, the IRS does not have the regulatory authority to declare Bitcoin a collectible, because Congress only granted authority to specify tangible items to be collectibles.  Although the IRS taken the position that precious metal backed ETFs are “collectibles,” it would be nearly impossible to make the case that Bitcoin should be treated similarly.[22]  The argument only works for ETFs because they hold physical assets and may be treated as trusts.

 

There is a strong argument that Casacius coins should be considered collectibles and taxed accordingly.

 

Bitcoin Traders Are Not Entitled To Forex 40/60 Rules

 

Foreign exchange traders may be entitled to preferential treatment of their gains under the “40/60” rules.  These rules basically state that gain or loss from certain contracts is considered to be 40% short-term capital (loss) and 60% long-term capital gain (loss).[23]  In addition, their holdings are market-to-market at the end of the year (that is, they are excepted from the general rule that requires “realization” of income or loss in order to take it on their tax return).  These rules do not benefit day traders in Bitcoin at the current point in time.

 

Foreign exchange contracts are entitled to these rules if several requirements are met, including as a prerequisite, that the contracts are:

 

1.     foreign currency contracts, which

2.     require delivery of, or the settlement of which depends on the value of, a foreign currency which is a currency in which positions are also traded through regulated futures markets,

3.     which is traded in the interbank market.[24]

 

Based on these prerequisites, it appears Bitcoin does not fit the bill.  It may be arguable that traders are engaging in foreign currency contracts, depending on the structure of the particular arrangement.  But, Bitcoin is not a currency traded on a regulated futures market, and an interbank market simply does not exist for the currency.  Thus, Bitcoin traders will not qualify without comprehensive regulation by Congress or an act of joint administrative action by the Treasury and Securities and Exchange Commission.

Foreign Nationals Trading on U.S. Brokerages

 

Foreign nationals are almost entirely exempt from capital gains taxes in the U.S.  A foreign national will only be subject to capital gains from the sale of Bitcoin if he is physically present in the U.S. for more than 183 days, or is a tax resident for the year of the sale.[25]  If the foreign national is partner in a U.S. business that exchanges Bitcoin as inventory, he is most likely subject to tax.

 

Foreign nationals who are casual Bitcoin speculators should not avoid using a U.S. based exchange for fear of paying taxes.  But, the individual may be required to prepare certain forms to demonstrate their foreign exempt status.  Foreign nationals are encouraged to seek competent counsel before making any investments or transfers into the U.S.  Many foreign persons are unaware of benefits offered under a treaty between their home country and the U.S.

 

Record Keeping

 

Planning for the future

 

It should be obvious that taxpayers must maintain accurate records regarding their Bitcoin

transactions.  This is extremely important for purposes of calculating both the amount of taxable gain and the holding period.  

 

Establishing a holding period does not have to be terribly difficult for the speculator who desires long-term capital gains treatment.  It can be quite simple with prudent planning ahead. If using a brokerage such as Coinbase, a .CSV (comma separated value) file may be available with a full list of trades.  These files open in Microsoft Excel, Google Docs, and many other solutions.


If storing Bitcoin in a wallet, the answer is terribly simple: rely on the block chain.  The block chain permanently records transactions to and from an address, along with the date and time.  The block chain is public, disinterested from the taxpayer, and tamper proof (there are some theoretical attacks).  

 

When transferring into cold storage, why not print out a snapshot of the address balance and history from Blockchain.info?  In fact, because the block chain does not purge old transactions, a print out may never be needed, although this is not recommended.  Moving the balance from address to address makes it harder to keep track of, but not impossible.  A little sleuthing may help a taxpayer establish his purchase date.

 

Figuring it out after the fact


If the funds are in a brokerage with no records, or the records otherwise unavailable, move the coin into an address under your control.  Record the detail from the block chain.  You can affirmatively prove you've held it from this point forward.

 

Obviously, that does not help the taxpayer demonstrate he owned it before the current date.  It may not be too late to trace it backwards through the block chain.  If it is, all hope is not lost.  Look for bank records, credit card receipts, email transfer notifications, etc.  Try and think outside the box.

 

In the worst-case scenario, taxpayers should be able to use a reasonable (and truthful) estimate of the purchase date on their tax return.  100% accuracy is not required.  It is not illegal to estimate a purchase date if it is truly unavailable.  But, be warned, if audited and challenged, a taxpayer who cannot come up with reasonable evidence will not prevail.

 

Losses and Deductions

 

Taxpayers who finish the year with net losses may not be surprised to learn they cannot utilize the full benefit of their losses.  Capital losses generally only offset capital gains.  A small concession from Congress allows $3,000 of capital loss to offset ordinary income (for example, from your salary).[26]  Unused losses are carried forward to the next year.

 

Many taxpayers will consider their Bitcoin an investment and a capital asset.  Those taxpayers are entitled to deduct expenses for the production of income as itemized deductions.[27]  These deductions are hard to come by, but do include attorney and CPA fees paid for the specific purpose of counseling on Bitcoin transactions.[28]  They might also include costs of “cold storage,” such as USB keys and safety deposit boxes.  Talk to your CPA about allowable deductions. 

 

Taxpayers can rejoice in that the wash sale rules do not apply under the current regulatory structure.  The code prescribes that the wash sale rules only apply to stock and securities.[29] 

Casualty Losses

 

Recent news had shed light on many Bitcoin holders who have experienced total loss of their Bitcoin.  Some of these investors held their Bitcoins in an online wallet that was hacked.  Others lost their private keys or have been robbed making an in-person sale.  These investors are entitled to at least some relief under the tax code.

 

If a loss was sustained in a trade or business (inventory) or transaction entered into for profit, but not part of a business (investment), the taxpayer is entitled to take a loss on his tax return in the same character.[30]  There does not appear to be any reason these rules should exempt Bitcoin casualties, but anything is possible.  For brokers, the loss of inventory would be ordinary loss.  For investors, the loss would be capital.  It is important to note that if the taxpayer suddenly recovers his previously claimed loss, he must recognize income equal to the loss previously taken. 

 

Losses may be limited, especially in the case of the loss of a private key or theft.[31]  Casualty losses from theft or “other casualty” subject to very strict limitations based on the size of the loss and the taxpayers adjusted gross income.

Disclosure of Foreign Bank Accounts and Financial Assets

 

Among the largest problems Bitcoin traders may face is the disclosure of foreign assets.  The compliance itself is relatively minor, but most tax preparers are wholly unaware of the requirements.  Even fewer will realize that Bitcoin transactions might trigger a duty to file.  Because the penalties involved are tremendous, it is imperative that taxpayers take a conservative position and file even in a borderline situation.

Foreign Account Tax Compliance Act (FATCA)

 

FATCA requires U.S. citizens and taxpayers who hold any interest in “specified foreign financial assets” valued in aggregate over $50,000 on the last day of the year, or over $75,000 at any time during the year, to disclose that asset.  These figures increase to $100,000 and $150,000 for married taxpayers filing joint returns.  The value of one specific asset or account does not matter.  FATCA disclosure is made annually on Form 8938 (Statement of Specified Foreign Financial Assets).

 

“Specified foreign financial assets” include:

 

      certain foreign financial assets held for investment purposes, and

      financial accounts maintained by a foreign financial institution.[32] 

 

The definition of a foreign financial asset probably does not encompass direct holdings of Bitcoin at the current point in time.  It would be a stretch to argue that Bitcoin is “foreign,” given the distributed nature of the network that includes U.S. operators.  Given enough time, Congress will likely create specific rules regarding stateless digital currency.  Therefore, it is unlikely that FATCA requires disclosure of Bitcoin itself, held in a wallet.

 

But, there is a strong argument that using foreign brokerages could trigger a disclosure requirement.  During Senate hearings on November 18 and 19, 2013, the director of FinCEN testified that the official position of Treasury was that current regulatory authority encompassed Bitcoin transactions.  Although the director specifically addressed its authority under the Bank Secrecy Act, it is not a far stretch that the agency would similarly believe that regulatory authority under FATCA encompasses such transactions. 

 

Financial Account...

 

A “financial account” is defined as any depository or custodial account.

 

Depositing Bitcoin into an online wallet service is arguably a custodial account, but probably not within the regulation if the taxpayer maintains possession of his own private and public keys.  In such a case, the taxpayer has not entrusted anything to the third party custodian. 

 

Depositing Bitcoin into a brokerage where the user does not know the specific address of his coin is clearly a custodial account:  the brokerage is taking control over the Bitcoin, and the taxpayer must submit a request to release any Bitcoin.  A specific example of this type of account is Coinbase, although they are domestic and outside the scope of the regulation.  Depositing Bitcoin in an online casino such as Satoshidice is also the establishment of a custodial account, although Satoshidice is probably not a financial institution (described below).

 

When a taxpayer sells his Bitcoin and leaves fiat currency in the brokerage’s account for safe-keeping, a custodial account has been established (for example, consider BTC-e or MtGox).  Compare this to a non-custodial method of dealing with fiat that Coinbase uses, where a balance is never held, and wire transfers are initiated instantly upon a sale.

 

… Maintained by a Foreign Financial Institution

 

A foreign financial institution is a financial institution that is not a U.S. entity (meaning that foreign branches of U.S. entities are not considered foreign), which:[33]

 

      accepts deposits in the ordinary course of a banking or similar business;

      holds financial assets for the account of others as a substantial part of its business; or

      is engaged (or holds itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interest (including a futures or forward contract or option) in such securities, partnership interests, or commodities.

 

A strong argument could be made that most Bitcoin brokerages meet the first requirement.  The day-to-day business of a Bitcoin brokerage consists of two main elements:  accepting deposits of fiat currency, and transacting in Bitcoin.  But, it is also far from clear that these rules should apply.  As such, it is not farfetched that the IRS would prevail if it challenged a taxpayer’s failure to disclose fiat accounts held in foreign Bitcoin brokerages.  It is strongly urged that taxpayers disclose any accounts that qualify.

Bank Secrecy Act (BSA)

 

The BSA requires U.S. citizens and tax residents disclose certain foreign bank accounts when the aggregate value of all qualifying accounts exceeds $10,000 at any point during the year.  This filing is still required even if it is duplicative.

 

The taxpayer’s disclosure obligation arises when the account is maintained in the name of, or for the benefit of the taxpayer or if the legal holder of title is acting on behalf of the taxpayer.  If the account is held in the name of a company or trust, disclosure is also required.  The BSA technically requires disclosure of foreign “financial accounts,” which includes accounts held on foreign branches of U.S. banks.[34]  Financial accounts include, but are not limited to the following types of accounts:

 

securities, brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution (or other person performing the services of a financial institution).[35]

 

Given the broad nature of that definition and FinCEN’s stated position (discussed above), it is hard to argue that the BSA does not apply when Bitcoin is converted into fiat currency and held at a foreign brokerage.  There is more room to debate whether the deposit of Bitcoin into a custodial account would require disclosure. 

 

The author is aware of the opinion that online poker accounts are exempt from FBAR reporting, and that this argument could be stretched to Bitcoin accounts.  This argument is essentially that regulations list certain accounts that must be disclosed, including “pooled” accounts that issue shares.  But, “pooled” accounts that don’t issue shares are exempt from disclosure, unless they meet one of the other requirements, such as being a “bank” or “securities” account.  The problem with the argument is that it ignores the fact that a “bank account” is defined very broadly as a “savings, demand deposit, checking, or any other account maintained with a  person in the business of banking.[36]  As expected, “the business of banking” is also undefined, leaving the Bitcoin holding taxpayer with little to go on.

 

The bottom line is that caution and conservatism is always urged when filing under the BSA

Disclosure under BSA is made annually (not on the same date as tax returns) on Treasury Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts, commonly known as “FBAR”).

  

Penalties for Failure to Disclose under FATCA and BSA

 

If you believe you have failed to file under FATCA or BSA for a prior year, you should immediately contact a tax attorney to assess the situation.

 

FATCA requires the annual filing of Form 8938.  Failure to file Form 8938 carries a baseline civil penalty of $10,000 for failure to file by the due date.  If the IRS sends a notice of failure to file, and the taxpayer does not correct the failure within 90 days, an additional $10,000 penalty is assessed for each 30 day period the failure continues.  The maximum total penalty is $60,000.  These penalties may be reduced if the taxpayer has reasonable cause.  Criminal penalties also exist.

 

BSA requires the annual filing of Form TD F 90-22.1.  Failure to file an FBAR carries a baseline civil penalty of up to $10,000.[37]  If the IRS finds the taxpayer had reasonable cause for the failure and the taxpayer corrects the filing, no penalties are imposed.  Any person who willfully fails to report an account is subject to a civil penalty equal to the greater of $100,000 or 50% of the balance in the account at the time of the violation.  Criminal penalties also exist.  Please note that these penalties may be assessed separately for each account.[38]

 

Failure to file Form TD F 90-22.1 also preserves the statute of limitations for the taxpayer’s entire return indefinitely, until three years after the form is eventually filed.[39]  If the form is never filed, the IRS can audit the return and assess penalties on the entire tax return at any time (even 100 years from now).  This is a sharp contrast to the general rule which limits the IRS from assessing penalties or interest after three years from the date the tax return was filed or due.[40]  This could prove to be detrimental if a taxpayer destroys his records after several years, assuming he was in the clear.

Closing Comments

 

The taxation of Bitcoin related transaction poses many unique problems that will require a significant body of legislation and administrative guidance.  For the time being, taxpayers will have to rely on analogy and technical readings of the law to determine their obligations.  This primer aims to present a sensible and broad overview of some of the many tax and compliance issues associated with Bitcoin.  It is far from comprehensive, and does not seek to address every plausible situation or policy matters.  Taxpayer should not and may not rely on this document as authority.  Rather, it is presented as a helpful tool. 

 

The author strongly encourages taxpayers to “come clean” to their CPAs or tax attorneys, and to err on the side of caution with respect to disclosing foreign assets.

 

IRS Circular 230 Disclosure

 

Any tax-related opinions in any part of this document or website (including any links) are not tax advice, and were not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding tax penalties or for promoting, marketing, or recommending to another party any transaction or matter addressed herein. Any user of this website should seek the advice of a competent, independent tax professional regarding that user’s particular circumstances. 

 

The author makes no claims, promises, or warranties about the accuracy of the information provided herein.  Tax advice cannot be provided on a general basis, and must be specifically tailored for each individual by his or her particular representative.   Everything included within is the author’s opinion and not a concrete fact.

 

 



[i]           Tyler S. Robbins, Esq. is an attorney licensed to practice in New York and New Jersey, whose area of interest is cross-border taxation and compliance.  Tyler can be reached at: btctaxinfo@gmail.com or by Bitmessage at: BM-2cWGqH2nzrV9DuTePPtieY1N8i4XeF19JG.



All citations to IRC are to the Internal Revenue Code of 1986, as amended.

 

[1]           See IRC §1001.

[2]           Gross income includes all income from whatever source derived, including income received in the form of property or services. See Treasury Regulations §1.61-1(a).  See also, Bittker & Lokken: Federal Taxation of Income, Estates, and Gifts (WG&L) (hereinafter “Bittker”), ¶ 5.1.2.

[3]           This fact is beyond debate and is a central part of U.S. tax theory.  See Bittker at ¶ 40.2.

[4]           There are always exceptions, beyond the scope of this discussion.

[5]                 See generally, IRC §1031.

[7]           IRC §988.

[8]           IRC §1221(a).

[9]           IRC §988(e).

[10]          IRC §988(c)(1)(C).

[11]         For a more comprehensive discussion of why Bitcoin is not a currency, see Abraham & Lowy, Taxation of Virtual currency, Tax Practice Tax Notes (Nov. 11, 2013).

[12]          IRC §1221(a)(1).

[13]          IRC §475(c)(2).

[14]          See IRC §1236(c).

[15]          IRC §1001.

[16]          See IRS Publication 551.

[17]          See Bittker, ¶ 41.7.4.

[18]          See IRC §1(h); IRC §1222(3).

[19]          IRC §1411.

[20]          IRC §988.

[21]          IRC §408(m).

[22]          See  PMTA 2008-01809 (5/2/2008).

[23]          IRC §1256.

[24]          IRC §1256(g).

[25]          See IRC §871(a)(2).

[26]          IRC §1211(b).

[27]          IRC §212.

[29]          IRC §1091.

[30]          IRC §165(c).

[31]          See IRC §165(h).

[33]          Id.

[35]          Id.;  31 C.F.R. §1010.350(c).

[37]          31 U.S.C. §5321.

[38]          Internal Revenue Manual 4.26.16.4 (07-01-2008).

[39]          IRC §6501(c)(8).

[40]          IRC §6501(a).

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Change log:
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  • 11/26/13 - added comment about 988 requirements
  • 11/23/13 - stylistic changes, brief discussion about 1031 exchanges, record-keeping and establishing purchase date
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