The Biden’s Administration’s Fiscal Year 2023 Revenue Proposal includes “Modernize Rules” to address Digital Assets that will require reporting by certain Taxpayers of Foreign Digital Asset Accounts. Tax compliance and enforcement with respect to digital assets has become a growing problem for the US Government given that the digital asset industry is web based, and Taxpayers can conduct transactions with offshore digital asset exchanges and wallet providers 100% through the internet. The sentiment is that the digital asset market can provide a US Taxpayer with the ability to conceal assets and taxable income via offshore digital asset exchanges and wallet providers. Moreover, US Taxpayers could circumvent US tax reporting by creating “entities” and utilizing the entities as conduits to transact. Having said that, the bottom line is that Taxpayers with digital assets ought to:
- be aware of their digital asset transactions
- understand their engagement with their service providers
- acknowledge that third-party digital asset reporting is coming
FATCA reporting for Digital Asset Accounts
Under the current law, Section 6038D of the Internal Revenue Code (IRC) requires any individual residing in the U.S. that holds an interest in one or more specified foreign financial assets with an aggregate value of at least $50,000 during a taxable year to attach Form 8938 (Statement of Specified Foreign Financial Asset) to an individual’s tax return by the due date (including extensions) for that tax return.
Section 6038D requirements also apply to domestic entities formed or for those that have the purpose of holding specified foreign financial assets. In sum, reporting for:
- a financial account maintained by a financial institution defined by section 1471 of the IRC
- certain specified assets not held in a financial account maintained by such a financial institution
The 2023 Proposal amends section 6038D(b) of the IRC to require reporting with respect to a new third category of asset that would be any account that holds digital assets maintained by a foreign digital asset exchange or other foreign digital asset service provider (a “foreign digital asset account”). Reporting will be required only for Taxpayers that hold an aggregate value of all three categories of assets in-excess-of $50,000. A foreign digital asset account would be defined based on where the exchange or service provider is organized or established. The proposal would be effective for returns required to be filed after December 31, 2022.
Taxpayers will incur penalties for non-reporting or incorrect reporting of digital assets
Failure to provide the required information for a taxable year is subject to a penalty of between $10,000 and $60,000 for each such failure, absent reasonable cause. In addition, the accuracy related penalty on underpayment of tax in section 6662 of the IRC (typically 20 percent of the underpayment) is increased to 40 percent for an underpayment that is attributable to a transaction involving undisclosed foreign financial assets.