Are Cryptocurrencies Subject to FBAR and Form 8938 Reporting?

by Sanford Millar
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Sanford Millar - Law Offices of Sanford I. Millar

On May 2, 2018 The Section of Taxation of the ABA issued its “Comments Regarding OVDP and Streamlined Procedures” in the form of a lengthy letter to Acting IRS Commissioner Kautter.  Section II B provides “Guidance on Treatment of Undisclosed Cryptocurrencies”.   It is reprinted in pertinent part below (footnotes have been omitted in the interests of brevity.  The reader is directed to the full letter for a comprehensive overview of the subject.

Scope of the Problem:  Estimated $25 Billion Plus Potential Tax Liabilities

Concurrent with the evolution of the cryptocurrencies, the Department of Treasury (“Treasury”) and the Service have focused on taxpayers who have unreported foreign financial assets and accounts. Most recently, the Service issued News Release IR 2018-71, reminding taxpayers that virtual currency transactions “are taxable by law just like transactions in any other property.” Cryptocurrency-related tax liabilities are estimated to be $25 billion as a result of $92 billion of taxable gains for U.S. cryptocurrency investors during 2017 alone.

Overview Clarification Needed:

“Guidance on Undisclosed Cryptocurrency for Offshore Programs

To assist taxpayers with the voluntary reporting of offshore virtual currencies held in foreign cryptocurrency exchanges and wallets (e.g., Bitcoin, Ether, Ripple, etc.), we recommend that the Service provide clarification as to whether the reporting of these assets is required for purposes of the FBAR and Form 8938. This guidance should clarify the difference in reporting between cryptocurrency held in a wallet that is linked to an exchange as compared to cryptocurrency held in a wallet not linked to any exchange. As stated …in Notice 2014-21, 31 the Service determined that cryptocurrencies were “property” (rather than currencies) for federal income tax purposes. However, Notice 2014-21 did not provide guidance with respect to a taxpayer’s reporting requirement(s) in the context of FBARs and Forms 8938. U.S. citizens, lawful permanent residents, persons with substantial presence in the United States, and U.S. entities (i.e., U.S. persons) must file an FBAR33 with FinCEN if the person has a financial interest in, or authority over, any financial account outside of the United States where the aggregate maximum value of the account(s) exceeds $10,000 at any time during the calendar year.

For purposes of FBAR reporting requirements, a reportable “financial account” includes the following:

  1. Banks accounts (e.g., savings accounts), checking accounts, time deposits or any other account maintained at a financial institution;
  2. Securities accounts such as brokerage or custodial accounts;
  3. Commodity futures or options accounts;
  4. Insurance policies or annuity contracts which have a cash value;
  5. Mutual funds or pooled funds; and
  6. Some pension funds and retirements accounts (excluding those under sections401 (a), 403(a), or 403(b)).

Very generally, a “U.S. person” has a “financial interest” where: (i) the U.S. person is the beneficial owner of the account or has legal title to the account; or (ii) the holder of the account is a person acting as an agent, nominee, attorney, or otherwise a person acting on behalf of the U.S. person with respect to the account.”

The Reporting Dilemma.

“It is unclear whether a taxpayer holding cryptocurrencies on a foreign cryptocurrency exchange (e.g., Xapo.com or Binance.com) or in a wallet maintained by a foreign wallet service provider (e.g., Blockchain.com) is required to report the account(s) on an FBAR as it is unclear whether cryptocurrencies may qualify as a reportable account for FBAR purposes. There is tension between the Service’s classification of cryptocurrency as “property,” the Securities Exchange Commission’s (“SEC”) classification of cryptocurrency, in certain circumstances, as a “security,” and the Commodity Futures Trading Commission’s (“CFTC”) classification of  cryptocurrency as a “commodity.” This tension is perhaps most pronounced in the context of the FBAR reporting requirements, which blend concepts of tax, securities, commodities, and money and finance laws. On the one hand, if cryptocurrency is property, then it is arguably not subject to FBAR reporting requirements because it is not, under the current regulatory definitions, a “bank, securities, or other financial account.” On the other hand, if cryptocurrency is a “security,” then FBAR reporting requirements may apply under the general rule: “[e]ach United States person having a financial interest in, or signature authority over, a bank, securities, or other financial account in a foreign country shall report such relationship to the Commissioner…” Moreover, by treating cryptocurrency as “property,” the answer to whether cryptocurrency held in foreign wallets must be reported likely depends on what functions the wallet provider actually provides, which may be difficult for taxpayers to determine in many cases. Furthermore, it is unclear how these requirements may apply to taxpayers who hold cryptocurrencies directly on a distributed blockchain.

Additional guidance is needed with respect to whether, and the extent to which, the FBAR reporting requirements apply to cryptocurrency. Assuming an FBAR may be required in particular cases, it would also be helpful if guidance addresses the differences in filing requirements for cryptocurrency held on an exchange, cryptocurrency held  through a wallet service company (custodial or noncustodial), or cryptocurrency held directly through a wallet address maintained by the taxpayer. We believe that cryptocurrency that is held directly by a taxpayer or held through a noncustodial wallet should not be reportable on the FBAR as there is no “financial account” maintained by a third party as there is with other reportable accounts.

Form 8938: Specified Foreign Financial Assets.

In addition to the FBAR, U.S. persons who are “specified individuals” or “specified domestic entities” must report “specified foreign financial assets” on Form 8938 with their annual income tax returns. The financial assets that must be reported on Form 8938 are broader than what is required to be reported on an FBAR, and include among other categories, “any financial account . . . maintained by a foreign financial institution” and “any interest in a foreign entity.” For example, a taxpayer holding cryptocurrencies on a foreign exchange or a wallet may be required to report the cryptocurrencies on Form 8938 given that the taxpayer is holding a financial account (the wallet) maintained by a foreign financial institution (the exchange). To assist taxpayers with accurate reporting of cryptocurrencies for purposes of Form 8938, it would be helpful if the Service issued a notice clarifying the reporting requirements for cryptocurrencies held “offshore” through an exchange or wallet service company (custodial or noncustodial) that is formed outside of the United States and for cryptocurrencies held directly by the taxpayer on a distributed blockchain.”

Given the uncertainty about filing FBARS and Form 8938, is it time for a Voluntary Disclosure Program for taxpayer who have or had cryptocurrencies in a foreign exchange or wallet?  The Tax Section apparently thinks so.

“Framework for a Cryptocurrency Voluntary Disclosure Program

 U.S. taxpayers may disclose unreported federal income tax liabilities from cryptocurrency transactions that include a foreign asset component through either the 2014 OVDP or the Streamlined procedures. However, any penalties, much less the OVDP penalties, may be unduly harsh in the context of taxpayers who failed to properly report cryptocurrency transactions when so little guidance has been issued and so much uncertainty exists as to if and when taxpayers with cryptocurrency must file FBARs, Forms 8938, or other international forms.

We recommend that the Service offer an offshore voluntary compliance initiative focused on virtual currency (and equivalent assets) for a limited time that mirrors the penalty regime contained in Revenue Procedure 2003-11 (from which the 2003 OVCI originated).40 This would allow taxpayers who have underreported their U.S. tax liabilities relating solely to cryptocurrency through financial arrangements that relate to foreign asset noncompliance, an opportunity to correct their past noncompliance with a penalty regime (and in a manner) more appropriate to their circumstances. In exchange for filing amended or delinquent returns for a three-year period and paying all tax, delinquency penalties, and accrued interest, the Service should agree to waive all other applicable penalties.”

My Opinion

While professionals and taxpayers wait for “guidance” FBARS and Forms 8938 are due by October 15, 2018 (for taxpayers on extension) for tax year ending December 31, 2017.  Should FBARS and Form 8938 be filed or not and how should late FBARS and Forms 8938 be dealt with?  These issues require legal advice from professional skilled in the area and to whom taxpayers fully disclose all facts.  The ultimate decision is that of the taxpayer, but the obligation to report cryptocurrency income is clear and perhaps it is the only clear point in this area, but the potential penalties for “willfully failing to file an FBAR” are the greater of $100,000 or 50% of the highest account balance per year for up to six (6) years.  The penalty for failing to file a Form 8938 is $10,000 per year and suspension of the Statute of Limitations on the entire return remains open.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Sanford Millar, Law Offices of Sanford I. Millar | Attorney Advertising

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