By Anthony Diosdi
Cryptocurrency is a type of digital or virtual currency that uses cryptography for security. Virtual currency is a digital representation of value, other than a representation of the U.S. dollar or a foreign currency, that functions as a unit of account, a store of value, and a medium of exchange.
Cryptocurrency allows parties to transact directly without an intermediary using blockchain technology, a shared distributed ledger that verifies, records, and settles transactions on a secure, encrypted network. Although some major retailers accept cryptocurrencies like Bitcoin and Ethereum, cryptocurrency is not money. Money means coin and paper money that Congress declares is legal tender. Because cryptocurrencies are sometimes other than money, what they are varies depending on the perspective from which they are viewed. For example, the Securities and Exchange Commission has declared cryptocurrencies to be “securities” under the securities laws, the Commodity Futures Trading Commission has declared them to be “commodities” under the Commodity Exchange Act, and the Internal Revenue Service or (“IRS”) has declared them to be “property” for federal tax purposes. Cryptocurrencies are extremely volatile, especially compared with conventional financial instruments such as stocks and bonds. That volatility plays a central role in the appeal of virtual currency for some.
The Taxation of Cryptocurrency
The U.S. is not alone in treating virtual currencies as property and not currency for tax purposes. Other countries, such as Australia, Canada, Germany, and the U.K., have adopted similar tax treatments for cryptocurrencies. IRS Notice 2014-21, provides that taxpayers must recognize gain or loss on the exchange of virtual currency for cash or for other property. Notice 2014-21 concluded that “convertible virtual currency,” i.e., virtual currency that has an equivalent value in fiat currency or is used as a substitute for fiat currency, is property that is not currency under Internal Revenue Code Section 988. As a result, “[g]eneral tax principles applicable to property transactions apply to transactions using virtual currency.”
Gain or loss is, thus, recognized and taxable, every time that virtual currency is sold or used to purchase goods or services, including other types of virtual currency. To determine the amount of capital gain or loss, an individual using cryptocurrency must know the basis of the virtual currency and the fair market value of the cryptocurrency when sold or otherwise transferred. In order to determine the proper capital gains rate, a determination must be made how long the cryptocurrency was held before its liquidation. Short-term capital gain is the gain occurring from the sale or exchange of virtual currency when it is held for one year or less. Long term capital gain is the gain that occurs from the sale or exchange of virtual currency when it is held for more than one year. Under the current tax rate, long-term capital gains are taxed at federal income tax rates up to 20 percent, as well as at applicable state and local tax rates. In addition, there may be in certain cases a 3.8 percent Medicare Tax.
Basis of Cryptocurrencies For Tax Purposes
As discussed above, cryptocurrency is treated as a capital asset for income tax purposes whenever it is sold or otherwise disposed of. This means that an investor in cryptocurrency must determine his or her cost basis in the property. The cost basis is the amount an investor spent to acquire an asset. This includes the purchase price, transaction fees, commissions paid, and any other relevant costs. At first glance, calculating the cost or initial basis in virtual currency seems simple. When U.S. dollars are used to acquire cryptocurrency, the basis in the cryptocurrency is the amount of fiat currency used to purchase the virtual currency. This is no different than the rules for determining the basis in any other capital asset. However, determining the basis in cryptocurrency quickly becomes more difficult after this initial stage in basis calculation.
The main reason it can be difficult to determine the basis of cryptocurrency is the method used to acquire the virtual currency. Cryptocurrencies are often acquired through a cryptocurrency trading platform or exchange. In these cases, the cost basis of the cryptocurrency is the amount that is recorded by the cryptocurrency exchange for that transaction. However, if the acquisition of the cryptocurrency happens “off-chain,” which means the transaction is not recorded on the distribution ledger, then the basis is the amount that the virtual currency was trading for on the exchange at the date and time the transaction would have been recorded on the ledger if it had been an “on-chain” transaction. If cryptocurrency is acquired in a peer-to-peer transaction or some other transaction that does not involve a platform or exchange, the basis of the cryptocurrency is determined at the date and time the transaction is recorded on the distribution ledger or would have been recorded on the ledger if it had been an on-chain transaction.
The method by which a cryptocurrency is acquired is not the only factor that affects how it will be later taxed when it is transferred. The size of the gain or loss recognized, as well as the applicable holding period (i.e., short-term or long-term), can also be affected by the method of tax accounting used in connection with the transfer. Immediately following the IRS’s release of Notice 2014-21, it was thought that since virtual currencies were usually held for investment purposes, like stock, they should be subject to the same basis and accounting rules applicable to stock. In other words, investors in virtual currencies had the option of choosing either the first-in, first-out (“FIFO”) method or first-in, first-out (“LIFO”) method of accounting when determining which units of a virtual currency were being transferred in a transaction. However, in 2019, the IRS issued an expanded set of FAQs, which clarified that the FIFO method was the only method that can be used if the investor does not specifically identify the transferred units. According to the IRS, an investor can identify a specific unit of virtual currency either by documenting the unit’s unique digital identifier (such as a private key, public key, and address) or by records showing the transaction information for all units of a specific virtual currency held in a single account, wallet, or address.
This ability to use specific identification in lieu of the FIFO method gives an investor some flexibility in picking the most advantageous tax treatment. Another challenge is basis calculation is when an investor exchanges one type of cryptocurrency for another type. These exchanges often arise when investors cannot directly purchase units of a new type of virtual currency by using fiat currency. Instead, the new cryptocurrency can only be acquired by exchanging units of a well-established cryptocurrency, such as Bitcoin or Ethereum, for units of new virtual currency. As a result, this exchange of one type of cryptocurrency for another type is treated as a simultaneous sale and purchase where one capital asset (e.g., Bitcoin or Ethereum) is sold, and the proceeds from such sale are deemed to be used to purchase another capital asset (i.e., the new cryptocurrency). These exchange transactions trigger not only a taxable event from the sale, but also the need to calculate the basis of the purchased cryptocurrency.
The Taxation of Mining Cryptocurrency
We often hear of mining cryptocurrency. Cryptocurrency mining is the process in which transactions between users are verified and added to the blockchain distributed ledger. The process of mining is also responsible for introducing new units into the existing supply of units in circulation. The IRS has not provided detailed guidance regarding the taxation of mining virtual currency, although in Notice 2014-21, the IRS did confirm that the virtual currency that a taxpayer receives from successful mining activities is includible in the taxpayer’s gross income at the virtual currency’s fair market value as of the date of receipt. The income resulting from mining virtual currency may also be subject to self-employment tax. See IRS Notice 2014-21, Q-8 and Q-9.
The Tax Controversy of Hard Forks
In 2018, the IRS launched a virtual currency taxation awareness campaign that evolved into a targeted compliance effort in 2019 aimed at taxpayers with virtual currency transactions who failed to report the resulting income and pay the associated taxes. In 2019, the IRS also issued Revenue Ruling 2019-24 which provides guidance regarding the taxation of “hard forks” and “air drops.”
For the most part, a hard fork of a cryptocurrency involves a software update that materially changes the blockchain’s operational protocol. These changes typically result in the creation of a new type of cryptocurrency. Transactions involving this new virtual currency are recorded on a new distributed ledger that is separate and distinct from the distributed ledger of the existing or legacy cryptocurrency. A hard fork does not extinguish or force an exchange of the legacy cryptocurrency. The legacy cryptocurrency will continue to exist after the hard fork, and transactions involving it will continue to be possible and will be recorded on the legacy cryptocurrency’s distributed ledger. A hard fork does not necessarily reduce the fair market value of the legacy cryptocurrency. Indeed, the fair market value of the legacy currency may even rise following the hard fork depending on market sentiment and demand.
In Revenue Ruling 2019-24, the IRS took the view that any new cryptocurrency that an investor receives in a hard fork is to be recognized by the investor as ordinary gross income in an amount equal to the new cryptocurrency’s fair market value at the date and time he or she acquires dominion and control over the property such that the investor can dispose of it. This fair market value, in turn, is the investor’s basis in the new cryptocurrency for subsequent transfers. The example provided in the ruling presupposes that there will always be a fair market value for the new cryptocurrency at the time the investor acquires the ability to dispose of it. However, given the relative newness of the cryptocurrency received in a hard fork, it may not always be the case that such a valuation can be readily determined at that time.
Revenue Ruling 2019-24 also clarified the tax treatment of an air drop in correction with a hard fork. An air drop is a means of distributing units of a cryptocurrency to the distributed ledger addresses of multiple taxpayers by recording the distributed units on the distributed ledger. According to the IRS, such a recording, by itself, may not be sufficient to confer dominion and control to an investor in the new cryptocurrency. Instead, the investor will be treated as receiving the units of the new currency when he or she acquires the ability to transfer, sell, exchange, or otherwise dispose of the new currency. Until the investor acquires this ability, no units will be treated as having been received by the investor. A particular challenge with this treatment is that investors may not be aware that an airdrop has occurred.
Virtual Currency Received for Services
If an investor receives virtual currency in exchange for services, the income is the fair market value of the virtual currency on the date acquired and is possibly subject to self-employment tax. The foundation for this treatment can be found in Internal Revenue Code Section 83. Under Section 83, which deals with property transferred in connection with performance of services, property transferred in exchange for services is immediately taxable at the time the property is transferable or there is not a substantial risk of forfeiture. In the virtual currency context, this would occur when the cryptocurrency is credited and available for transfer in exchange for the service.
Additional guidance is provided by Revenue Ruling 80-52, which discusses a barter club that uses “credit units” as a medium of exchange. The club debited or credited members’ accounts for goods or services received or rendered to other members. The ruling stated as follows:
In this case, A, B, and C received income in the form of a valuable right represented by credit units that can be used immediately to purchase goods or services offered by other members of the barter club. There are no restrictions on their use of the credit units because A, B, and C are free to use the credit units to produce goods or services when the credit units are credited to their accounts.
Consequently, according to Revenue Ruling 80-52, members receiving credits in their barter club accounts were required to recognize income pursuant to Section 83 of the Internal Revenue Code.
Losses of Individuals Trading in Cryptocurrencies
Sometimes individuals trading in cryptocurrencies suffer losses. Internal Revenue Code Section 165(a) allows a deduction for losses sustained during the tax year not compensated by insurance or otherwise. However, Section 165(c) of the Internal Revenue Code limits deductions by individuals to those losses incurred in a trade or business or losses incurred in any transaction entered into for profit. Thus, a trader may only use losses from virtual currency trades against similar gains. This is the case even if a gain on the same transaction would be taxable. In addition, the deduction for capital losses is limited to the extent allowed under Internal Revenue Code Sections 1211 and 1212. Under these rules, an individual investor is allowed to utilize losses to the extent of the gains from sales, plus $3,000 ($1,500 in the case of a married individual filing a separate return). Since cryptocurrencies are not securities, an investor cannot utilize the Section 165(g) worthless security loss rules.
Theft of cryptocurrencies have been increasing. Although, Internal Revenue Code Section 165(c)(3) allows a deduction for certain casualty or theft losses, these losses are limited solely to losses of property “not connected with a trade or business or a transaction entered into for profit.” Given this limitation, it is unlikely that anyone will be able to deduct for theft (or casualty) losses on cryptocurrencies. Most cryptocurrency will be entered into by traders for profit without any connection with a trade or business.
Wash Sales Applied to Cryptocurrencies
In a wash sale, an investor sells or trades a security at a loss and then buys that security back again. Internal Revenue Code Section 1091 disallows as a wash sale any loss arising from the sale or disposition of stock or securities where, within 30 days before the date of the sale or within 30 days after such sale, the investor acquired or acquires substantially identical stock or securities. However, since cryptocurrency is not a security for federal tax purposes, the “wash sale rules” of Section 1091 do not apply to cryptocurrencies. Consequently, investors in cryptocurrencies can take advantage of this distinction by selling their cryptocurrencies at a loss, buy them back immediately, and still be able to claim the realized loss in the current tax year.
Treatment Tax Treatment of Cryptocurrency Options
A futures contract is a financial agreement between two parties to buy or sell an asset to each other on a specified expiration date in the future at a predetermined price. Both parties to a future are legally obligated to settle their respective obligations on the expiration date. In contrast, an option is a financial instrument in which its holder has the right but not obligation, to buy or sell to or from the options issuer at a predetermined price. Call options entitle their holders to buy the underlying asset. Both futures and options are either physically settled or cash settled. Physical settlement involves the transfer of the underlying asset itself. Cash settlement involves the cash payment of the difference between the predetermined price of the underlying asset and its fair market value at expiration or time of exercise. In the cryptocurrency ecosystem, a significant number of futures and options are cash settled.
Investors are generally not taxed on any gain or loss on a capital asset until the investor recognizes the gain or loss in a sale or other disposition of the asset. DEpending on how long the investor has held the asset, the gain or loss is characterized as either a short-term or long-term capital gain or loss and is taxed accordingly. However, in the case of futures and options, including those whose underlying assets are cryptocurrency, the holders of such contracts may be subject to the special rules of Internal Revenue Code Section 1256. Under these rules, the holder of a future or option falling within the definition of a “Section 1256 contract” is required to mark-to-market his or her open position in the contract on the last day of each tax year and to treat that position as being sold at that marked-to market value on such day. These special rules effectively compel Section 1256 contract holders to recognize, as a short-term capital gain or loss, a gain or loss that otherwise would have been a long-term capital gain or loss.
Nonetheless, every gain or loss on a Section 1256 contract – whether recognized at the end of a tax year pursuant to the mark-to-market requirements described above, or at any time during the tax year when the holder closes his or her position in a sale or offsetting transaction – are not subject to the tax rates that normally apply to capital gains and losses. Rather, Section 1256 contract gains and losses are subject to a blended tax rate where 60 percent of the gain or loss is taxed as long-term capital gain or loss, and the remaining 40 percent is taxed as short-term capital gain or loss, regardless of the holding period length. As a result, this 60/40 blended rate may provide a tax benefit in certain circumstances. For example, if an investor buys a Section 1256 contract in March and sells it three months later at a profit, then 60 percent of the gain (which otherwise would have been taxed at the short-term tax rate) will be taxed at the lower long-term tax rate even though the contract was held for only three months. The 60/40 treatment, however, is not available to a holder for whom the SEction 1256 contract is an ordinary income asset (e.g., a trader who trades these contracts in connection with a trade or business).
Section 1256 contracts qualifying for the 60/40 blended rate also entitle their holders to elect to carry back the losses they incur on these contracts one year to the three preceding years. This loss carryback election provides a form of income averaging not available to other taxpayers. If the election is made, taxpayers carry their net Section 1256 contract losses back to each of the three preceding years and apply these losses against the Section 1256 gains recognized in those prior years. Losses that are carried back are treated as if 60 percent of the losses were long-term and 40 percent were short-term.
Most cryptocurrency futures and options, however, are not Section 1256 contracts. This is because, in order to qualify, the cryptocurrency future or option must be either a “regulated futures contract” or a “nonequity option.” See IRC Section 1256(b)(1)(A) and (C). Only contracts traded on, or subject to the rules of, well-established and highly regulated exchanges or boards or trade can fall in either of these categories. Currently, not many cryptocurrency futures or options meet this requirement.
Estate and Gift Tax Issues for Nonresident Cryptocurrency Holders
Cryptocurrencies, like any other property, are generally subject to federal estate and gift tax when they are included in the estates of their owners at death or gifted to others prior to death. The estate and gift tax is assessed at a rate of 18 to 40 percent on the property’s value. In the case of property owners who are U.S. citizens or domiciliaries, all of their property wherever situated are taxable, but a unified credit allows them to exempt $12.92 million (for 2023) of property from tax. In the case of non-U.S. citizens or domiciliarias, only their U.S. situs assets are subject to tax, but the unified credit allowed to them is significantly smaller, exempting only $60,000 of property of U.S.-situs property from tax, unless an applicable treaty allows a greater credit. In addition, the unified credit for non-U.S. citizens or domiciliaries is available only to offset their estate tax. It cannot be used to offset their gift tax. In any event, the annual gift tax exclusion, which exempts $17,000 (for 2023) of property from gift tax, is available to everyone subject to the tax, regardless of citizenship status or domicile.
As mentioned above, federal estate and gift tax is assessed only on U.S. situs assets of non-U.S. citizens or domiciliaries. The IRS has yet to provide guidance on how to determine the situs of cryptocurrency for estate and gift tax purposes, or whether cryptocurrencies are tangible or intangible property for such purposes. The distinction between tangible and intangible property has particular relevance for gift tax purposes. This is because all gifts made by non-U.S. citizens or domiciliary of intangible property are not subject to U.S. gift tax, even if the gifted property is a U.S. situs asset. See IRC Section 2501(a)(2).
While arguments can be made that cryptocurrencies should be considered intangible property, and not tangible property similar to cash, there has been speculation that this may not be the case where a unique private key associated with cryptocurrency is stored or located on a hard drive. This is because access to the virtual currency units corresponding to that key will be permanently lost if the key is ever lost or stolen. For these reasons, the IRS may successfully argue that when a unique private key is stored or located on a hard drive in the United States, the corresponding cryptocurrency has a U.S. situs for estate and gift tax purposes. It should be noted that some U.S.-based cryptocurrency exchanges, such as Coinbase, main physical vaults of private keys and, thus, any cryptocurrency held on such an exchange would be at risk of being considered U.S. situs property. Until the IRS issues its guidance on this issue, the respective locations of the owner, the exchange, the servers, and the digital wallet (if any) will all need to be considered when determining the status of a cryptocurrency.
Charitable Considerations
Since cryptocurrencies are classified as property for federal tax purposes, donating of cryptocurrencies to public charities or certain private foundations are generally treated no differently than donations of capital assets. For this reason, donating appreciated cryptocurrency may be preferable to donating cash from the sale of the cryptocurrency. If the donation is made to a charity that is a recognized organization under the IRS rules, the donor will not recognize income, gain, or loss from the donation. Calculating the value of the contributed cryptocurrency for deduction purposes depends on the holding period of the donor. If the donor has held the cryptocurrency for more than one year, the value of the contribution is equal to the current value of the cryptocurrency. But, if the donor has held the cryptocurrency for one year or less, the value of the contribution is the lesser of the donor’s adjusted basis or the virtual currency’s fair market value.
The rules for reporting charitable contributions of cryptocurrency are essentially the same as those for other contributions of property to charitable organizations. When accepting cryptocurrency contributions, the charity should provide a contemporaneous written receipt of the contribution. In cases of deductions over $5,000, the charitable organization must sign a Form 8283 and provide the form to the donor.
Cryptocurrency Loans
Cryptocurrency investors are turning to lending primarily for liquidity reasons. By posting cryptocurrency as collateral, they can continue to invest in the virtual currency market while obtaining access to cash. There are two main types of cryptocurrency loans that are discussed below.
The first type of cryptocurrency loan involves one party (the borrower) borrowing virtual currency from another party (the lender) with the borrower posting collateral. The borrower agrees to return to the lender an identical amount of the same virtual currency at the end of the agreement and the lender agrees to return the collateral. These transactions are typically structured to resemble securities lending transactions. The borrower is free to sell or otherwise dispose of the virtual currency subject to the loan, and the lender is often allowed to sell or otherwise dispose of the collateral. If during the term of the agreement there is an airdrop or hard fork with respect to the virtual currency that was borrowed, the borrower transfers back to the lender units of virtual currency identical to those that were received in the airdrop or hard fork.
In the second type of transaction, a lender loans the borrower fiat currency and the borrower posts virtual currency with the lender as collateral. A principal objective of these transactions is for the borrower to monetize a virtual currency position without triggering a taxable sale. These transactions are relatively straightforward. When the loan matures, the borrower repays the lender the dollar amount of the loan plus interest, taking back virtual currency identical to what the borrower had posted as collateral. If during the term of the loan there is an airdrop or hard fork with respect to the virtual currency that was posted as collateral, the lender must transfer to the borrower virtual currency identical to those that were received in the airdrop or hard fork.
What is a Non Fungible Token (“NFT”) and How is a NFT Taxed
The concept of an NFT is to marry the world of digital assets with the security of cryptocurrencies. An NFT is a digital asset with a certification of authenticity which is protected by copyright law. When one purchases an NFT, that individual is acquiring a hacker-resistant, public proof of ownership of the digital asset. How an NFT is taxed depends on two factors. First, whether or not an individual created and sold the NFT. Second, whether or not an individual bought and sold the NFT as an investment.
Overview of the Tax Liability for a Creator of an NFT
The creator of an NFT is taxed at the time he or she sells an NFT. For example, let’s assume Bob creates an NFT. Let’s also assume that Bob sold the NFT for one Ether (ETH). Let’s assume that today’s exchange rate for one ETH is $1,976.59. In this case, Bob will report $1,976.59 of ordinary income associated with the sale of the NFT. However, Bob may be able to deduct any business related expenses associated with the creation and sale of the NFT to reduce the tax consequences of the sale.
Overview of the Tax Liability for NFT Investors
Some investors are betting big on NFT art. Others are acquiring NFTs just for publicity or bragging rights. Whatever the reason for investing in an NFT, the tax consequences associated with buying and selling an NFT is similar to trading digital currencies. Like cryptocurrency, the buying and selling of an NFT creates a taxable profit to the investor. Investors are subject to short or long term capital gains tax, plus 3.8 percent Medicare Tax, plus applicable state and local taxes.
For example, let’s assume that on April 1, 2021, Linda acquired an NFT worth $3,953.18 (2 ETH). Let’s also assume Linda used 2 ETH to buy the NFT. However, Linda acquired the two ETH used to purchase the NFT a number of years ago. At that time, the 2 ETHs were worth $400. When Linda purchases the NFT, she would incur long-term capital gains of $3,553.18 ($3,953.18 – $400 = $3,553.18). Since Linda held the 2 ETH for more than one year, she would be taxed at favorable long-term capital gain rates. Linda’s cost basis in the NFT would be $3,553.18.
If Linda were to sell this NFT in September 2021 for $10,000, she would have a short-term capital gain of $6,446.82 ($10,000 – $3,553.18). The gain is short-term because Linda did not hold the NFT for more than 12 months before she decided to sell it. Short-term gains are subject to less favorable rates. This means, Linda will be taxed at ordinary income tax rates on the gain in the NFT. Linda will also be subject to Medicare Tax, and applicable state and local taxes.
It should be noted that an NFT may also be taxed as collectible. Internal Revenue Code Section 408(m)(2) defines a collectible as: 1) any work of art; 2) any rug or antique; 3) any metal or gem; 4) any stamp or coin; 5) any alcoholic beverage; 6) any other tangible personal property specified by the Treasury. While it is clear that NFTs may be considered works of art, it is unclear whether or not an NFT can be considered a collectible. Whether or not an NFT can be considered a collectible for tax purposes can make a big difference to the investor’s tax bill. This is because the maximum long term capital gains rate on gains from the sale of most assets is 20 percent. On the other hand, the maximum rate on gains from the sale of collectibles is 28 percent. Whether or not NFTs can be taxed as a collectible will need to be determined on a case-by-case basis.
The Reporting of Cryptocurrency on an Individual Income Tax Return
The IRS is starting to track and enforce cryptocurrency compliance regarding virtual currency transactions. The individual 1040 tax returns require taxpayers to answer yes or no questions regarding whether the taxpayer was involved in the transfer of virtual currencies. Capital gains and losses are reported on Form 8949 and on Schedule D of Form 1040 for individual taxpayers. Ordinary income received from cryptocurrency is reported on Schedule 1 of Form 1040 for individuals. Any virtual currency received as compensation for services or disposed of in a sale to customers in a trade or business is reported in the same manner as the individual would report other income of the same type (i.e., on Form W-2 for wages or services on Schedule C).
Foreign Informational Return Reporting Consideration
It has been somewhat ambiguous whether virtual currency transactions are required to be reported on Form 8938 or FinCen Form 114 (also known as “FBAR”). These forms are required for the disclosure of foreign bank accounts or assets.
Taxpayers with specified foreign assets that exceed certain thresholds must report those assets to the IRS on Form 8938, Statement of Specified Foreign Financial Assets, which is filed with an income tax return. A specified foreign financial asset includes financial accounts maintained by a foreign financial institution or the following foreign financial assets if they are held for investment and not held in an account maintained by a financial institution: 1) stock or securities issued by someone that is not a U.S. person (including stock or securities issued by a person organized under the laws of a U.S. possession); 2) any interest in a foreign entity; and 3) any financial instrument or contract that has an issuer or counterparty that is not a U.S. person. Cryptocurrency cannot be considered stock, a security, or an interest in a foreign corporation. However, cryptocurrency may be considered a “financial instrument or contract that has an issuer or counterparty that is not a U.S. person.” Virtual currencies like Bitcoin and Ethereum only exist as digital representations of value. However, cryptocurrency has also been referred to as “smart contracts.” This is because virtual currencies are legally enforceable contracts which translate programming code into written blockchain for autonomous execution and enforcement. Under this broad and expanding definition of cryptocurrency, many U.S. cryptocurrency will likely have an 8938 filing requirement.
FBARs are used to report a U.S. person’s financial accounts in a foreign country. Under the current FBAR regulations, a U.S. person is not required to report cryptocurrency on an FBAR. However, on December 30, 2020, the Financial Crimes Enforcement Network (“FinCEN”) published the following guidance:
Currently, the Report of Foreign Bank and Financial Accounts (FBAR) regulations do not define a foreign account holding virtual currency as a type of reportable account. (See 31 C.F.R. 1010.350(c)). For that reason, at this time, a foreign account holding virtual currency is not reportable on the FBAR (unless it is a reportable account under 31 C.F.R. 1010.350 because it holds reportable assets besides virtual currency). However, FinCEN intends to propose to amend the regulations implementing the Bank Secrecy Act (BSA) regarding reports of foreign financial accounts (FBAR) to include virtual currency as a type of reportable account under 31 C.F.R. 1010.350.” See FinCEN Notice 2020-2.
With FinCEN providing notice that cryptocurrency reporting changes are coming for purposes of the FBAR, virtual currency holders must understand that their filing requirements with the IRS will likely increase in the very near future.
Conclusion
Overall, cryptocurrency is still an emerging asset class with a largely undefined tax framework. As a result, little authoritative guidance is available for investors with respect to basis tracking. Thus, cryptocurrency investors should adopt a method that is both thorough and consistent on what is known about the current law, until further guidance becomes available. Investors should seek guidance from an experienced tax attorney.
Anthony Diosdi is one of several tax attorneys and international tax attorneys at Diosdi Ching & Liu, LLP. Anthony Diosdi focuses a part of his practice on criminal tax enforcement, broad-based civil tax compliance and white collar matters generally. He also advises clients on the IRS voluntary disclosure program, with particular focus on disclosure related to offshore banking accounts.
Anthony Diosdi is a frequent speaker at international tax seminars. Anthony Diosdi is admitted to the California and Florida bars.
Diosdi Ching & Liu, LLP has offices in San Francisco, California, Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises throughout the United States. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
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.