By Anthony Diosdi
On January 1, 2021, the Anti-Money Laundering Act of 2020 was enacted into law. Under the Anti-Money Laundering Act of 2020, the Department of Treasury has the power to declare that cryptocurrency is a monetary instrument. As a result, certain cryptocurrency transactions must be reported to the Financial Crimes Enforcement Network or FinCEN (The Financial Crimes Enforcement Network is a bureau of the Department of the Treasury) as part of a financial institution’s anti-money laundering (“AML”) program. This article will discuss cryptocurrency trader’s obligation under the Anti-Money Laundering Act of 2020.
Money Transmitter Laws- What Cryptocurrency Traders Need to Know
If you are in the business of trading cryptocurrency, it is imperative that you understand the money transmitter laws. There are federal and state money transmitting laws. We will begin with the federal money transmitting laws. Federal law has defined cryptocurrency as a commodity. This classification is important because a community can be subject to federal regulations. In particular, FinCEN requires individuals and businesses that deal in commodities to be registered as money service businesses. These rules subject money service businesses to the United States Bank Secrecy Act (“BSA”).
In 1970, Congress enacted the BSA as part of the Currency and Foreign Transaction Reporting Act. This was codified in Title 31 (Money and Finance) of the U.S. Code. The purpose of the BSA is to prevent money laundering by reporting the filing of reports and retention of records would be helpful to the U.S. government in carrying out criminal, civil, tax, and regulatory investigations.
In 2013, FinCEN issued Fin-2013-G001, Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (Mar. 18, 2013). This guidance directly impacts all cryptocurrency traders because it brings them under BSA reporting obligations. This guidance established categories of cryptocurrency participants for the purpose of the rule: 1) those who accept and transmit convertible cryptocurrency; and 2) those who buy and sell cryptocurrency that could be classified as money transmitters as per the FinCEN regulations.
The guidance issued by FinCEN is very broad who is a money transmitter and thus has an obligation to file reports. Broadly speaking, FinCEN defines a money transmitter as someone that acts as an intermediary between two parties that sends or exchanges money for another currency. If a cryptocurrency trader is defined as a money transmitter, the individual or business must be registered with FinCEN and be licensed in any state it operates or conducts business in. To be in compliance with federal and state laws, a cryptocurrency money transmitter will need to comply with a number of rules discussed below.
Anti-Money Laundering Program Requirements for Money Services Businesses
Individuals and businesses in the trade or business of trading cryptocurrency are typically classified as a money services business (“MSB”). As a MSB, cryptocurrency trading businesses must adopt an AML Compliance Program that includes policies, procedures, and internal controls reasonably designed to assure compliance with the Bank Secrecy Act. As discussed above virtual currency exchangers are regulated money transmitters. As money transmitters, cryptocurrency traders, these individuals or businesses are required to comply with the Funds Transfer Rules (31 C.F.R. 1010.410(e)(2)(ii)) and Funds Travel Rules (31 C.F.R. Section 1010.410(f)(2)) for transactions of $3,000 or more.
Money transmitters that acts as the Transmittor’s Financial Institution (“TFI”) for virtual currency transactions are required to gain and record:
1) Name and address of the transmitter;
2) Amount of the order;
3) Execution date;
4) Any payment instructions received with the order;
5) Identity of the recipient’s financial institution;
6) Any form completed or signed by the customer sending the transfer.
TFI’s are also required to keep a record of the following items, if received:
1) Name and address of the recipient;
2) Account number of the recipient;
3) Any other identifier of the recipient.
Typically, virtual currency exchangers account holders do not meet the definition of established customers. Thus, cryptocurrency exchange businesses must gain, record, and verify the transmitter’s Taxpayer Identification Number (“TIN”). They must also gain and record the alien identification number or passport number and country of issuance for any consumer who does not have a TIN. Specific information for transactions of $3,000 or more must be passed on to the Recipient’s Financial Institution (“RFI”) as required by the “Funds Travel Rule.” The “Funds Travel Rule” is a BSA rule that requires financial institutions to pass certain information on to the next financial institution, in certain funds transmittals involving more than one financial institution.
For transactions to meet the Funds Travel Rule requirement, cryptocurrency exchange businesses must include and send the following in a transmittal order:
1) The name and the account number of the transmittor;
2) The address of the transmitter;
3) The amount of the transmitter order;
4) The execution date of the transmittal order;
5) The identity of the recipient’s financial order.
And as many of the following items as are received with the transmittal order:
1) The name and address of the recipient;
2) The account number of the recipient;
3) Any other specific identifier of the recipient;
4) Either the name and address or numerical identifier of the transmitter’s financial institution.
31 U.S.C. Section 5318(h) requires cryptocurrency money transmitter businesses to establish an AML. The AML must contain policies, and internal controls reasonably designed to prevent a business from being used to facilitate financial crimes. The policies and procedures of the AML must address the requirement of collecting additional information for customers conducting transactions of $3,000 or more per the recordkeeping requirements.
At a minimum, an AML should designate a Compliance Officer for each virtual currency trader. The Compliance Officer’s duties should include monitoring transactions, ensuring employees receive training, and a periodic independent review is conducted. The Compliance Officer should also ensure the business is meeting the reporting requirements, updating the AML Compliance Program when changes to regulatory and statutory requirements are changed or amended as well as ensuring employee training and independent reviews are conducted. The designated Compliance Officer should review the position’s duties and responsibilities as outlined in the AML Compliance Program. He or she should ensure that the stated responsibilities are conducted and that the business is meeting BSA requirements.
A MSB should conduct periodic employee training based on the entity’s specific risk. Employee training should include, but not limited to: Office of Foreign Assets Control (“OFAC”), Currency Transaction Reports (“CTRs”), Customer Identification Program (“CIP”), Customer Due Diligence/Enhanced Due Diligence (“CDD/EDD”), Suspicious activity reporting and recordkeeping documentation requirements.
31 C.F.R. Section 1022.380(b) – Renewal of Money Services Registration
All cryptocurrency money transmitter businesses must register with FinCEN using the BSA E-Filing System. BSA E-Filing is a free, web-based electronic filing system that allows money transmitter businesses to submit their registration of Money Service Business (RMSB or FinCEN Form 107) and other BSA reports through a secure network. Pursuant to 31 C.F.R. Section 103.41, a copy of the filed registration form, an estimate of business volume, information regarding ownership or control of the business, and a list of agents for the business must be retained at a location in the U.S. for a period of five years and must be updated annually. After initial registration, an MSB is required to renew its registration on or before December 31 of its two-year registration period.
31 C.F.R. Section 1010.410(e)(2)(ii)- Transmittal Orders Not Made in person – Money Services Business
As a MSB, cryptotrader businesses are required to verify the person placing a transmittal order in the amount of $3,000 or more, or more, prior to accepting funds. For transmitters who are not established customers and the transmittal is not made in person, the virtual currency business must obtain and retain a record of the name and address of the person placing the transmittal order as well as the person’s identification number (e.g., social security or employer identification number). If the person has no taxpayer identification number, a record of their alien identification number or passport number and country of issuance, if known by the person placing the order, or a notification in the record of lack thereof.
Filing Requirements with BSA
FinCEN established extensive reporting requirements for cryptocurrency money transmitting businesses. Below is a partial list of the reporting requirements for cryptocurrency money transmitting businesses:
According to 31 U.S.C. Section 5313 and 31 C.F.R. Section 103.22, cryptocurrency money transmitting businesses must file FinCEN Form 104, CTR within 15 days whenever a transaction or series of transactions in currency: 1) involves more than $10,000 in cash or cash-out; 2) is conducted by, or on behalf of, the same person; and 3) is conducted on the same business day.
In addition, 31 C.F.R. Section 103.20 provides that a cryptocurrency money transmitting business must file FinCEN Form 109, Suspicious Activity Report (“SAR”) if a transaction involves or aggregates funds or other assets of $2,000 or more if the cryptocurrency money transmitting business knows, suspects, or has reason to suspect that any transaction: 1) involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity as part of a plan to violate or evade any federal law or regulation or to avoid any transaction reporting requirement under federal law or regulation; 2) is designed, whether through structuring or other means, to evade any requirement of BSA; 3) serves no business or apparent lawful purpose, and the cryptocurrency money transmitting business knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction; and 3) involves use of the cryptocurrency money transmitting business to facilitate criminal activity.
A cryptocurrency money transmitting business must file a SAR within 30 days days after becoming aware of the suspicious transaction. A copy of the completed SAR must be retained for five years from the date the return is filed with FinCEN.
The Importance of Obtaining a State-Issued Money Transmitter License
The last step to come into compliance with BSA is for a cryptocurrency money transmitter to obtain a license from the state it conducts business. There exists no uniformity among the states when it comes to regulating cryptocurrency businesses. For example, under the California money transmitter statute, businesses receiving money or monetary value for transmission within or outside the U.S. must obtain a money transmitter license, whether the transmissions are physically in the state, or with, to or from persons located in California. California’s Money Transmitter Act does not address cryptocurrencies currencies and the state has not provided official guidance on the applicability of its money transmitter statute to cryptocurrencies.
On the other hand, Florida specifically requires individuals engaged in the business of selling virtual currency in that state to obtain a license under the state’s money transmission law. The Florida Office of Financial Regulation cited the Florida Third District Court of Appeals decision in State v. Espinoza, 264 So. 3d 1055 (Fla. 3d DCA 2019). In this case, the Third District Court of Appeals reversed the trial court’s decision and “decided that selling bitcoin requires a Florida money services business license. Espinoza was charged with operating an unlicensed money service business by selling bitcoin. The case held that bitcoin is a “payment instrument,” thereby bringing the sale of bitcoin within Florida’s money transmission laws. As a result, persons and businesses engaged in the business of selling cryptocurrency in Florida, including in a noncustodial capacity, must obtain a license under the state’s money transmission law.
Failure to register as a cryptocurrency business with FinCEN can result in a civil penalty of $5,000 for each violation. 31 CFR 103.41 provides a civil penalty of $5,000 for each day a registration violation continues. Federal law also authorizes a prison sentence of up to five years for BSA violations. In addition, 18 U.S.C. Section 1960 (the federal racketeering law) makes the failure to maintain any required state money transmitter license a federal crime. Finally, State v. Espinoza indicates that the sale of cryptocurrency without a state license could trigger a state felony criminal prosecution.
If you are in the business of selling cryptocurrency, you should consult with a qualified attorney to advise you of your state and federal compliance obligations. We have advised many clients regarding cryptocurrency matters. We have also represented cryptocurrency businesses before Department of Treasury BSA audits.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony focuses his practice on domestic and international tax planning for multinational companies, closely held businesses, and individuals. Anthony has written numerous articles on international tax planning and frequently provides continuing educational programs to other tax professionals.
He has assisted companies with a number of international tax issues, including Subpart F, GILTI, and FDII planning, foreign tax credit planning, and tax-efficient cash repatriation strategies. Anthony also regularly advises foreign individuals on tax efficient mechanisms for doing business in the United States, investing in U.S. real estate, and pre-immigration planning. Anthony is a member of the California and Florida bars. He can be reached at 415-318-3990 or firstname.lastname@example.org.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.