Editor: Kevin D. Anderson, CPA, J.D.
Foreign Income & Taxpayers
Few—if any—requests for information about filing FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR), or complying with the Foreign Account Tax Compliance Act (FATCA), P.L. 111-147, include questions about ownership of digital currencies. But based on recent guidance and the popularity of these new digital currencies, it seems that they should.
In 2009, a programmer operating under the name "Satoshi Nakamoto" created a cryptography-based peer-to-peer digital currency known as "bitcoin." Recently, bitcoin has exploded in popularity online. In 2013 and early 2014, mainstream websites such as newegg.com, overstock.com, okcupid.com, baidu.com, and reddit.com began accepting bitcoins as a payment option. Bitpay, a bitcoin payment processor based in Atlanta, reported a more than tenfold increase in the number of merchants using its service in 2013. Numerous restaurants and retailers along the Pacific Coast now accept bitcoins in addition to cash and credit cards. Some overseas colleges have begun accepting tuition payments in bitcoins. This year, Olympic athletes from India and Jamaica used dogecoin, another cryptography-based digital currency, to help pay for their Olympic training and travel expenses.
Bitcoin is not backed or issued by any government. Instead, like precious metals, bitcoins are "mined" from the bitcoin network itself by virtual "miners" that process bitcoin transactions. Currently, the bitcoin network awards a small number of bitcoins to the first miner to process each block of transactions. There is a fixed "lode" of 21 million bitcoins that can be mined; 12 million of those have already been mined. Once the entire lode has been mined, bitcoins can be acquired only from existing holders. Once mined or otherwise acquired, bitcoins are stored as numerical balances located at "bitcoin addresses." A cryptographic private key is used to access the bitcoin address, somewhat like a combination to a safe. A user generally stores one or more private keys in a file known as a "wallet." Most digital currencies, including dogecoin, are generally similar to bitcoin but differ with regard to the lode of minable coins and the technical details associated with processing transactions of the respective currency.
Historically, the exchange rate between U.S. dollars and bitcoins has been extremely volatile, rising and falling by double digits numerous times over the course of its brief history. At the beginning of 2013, each bitcoin was worth roughly $10. By the fall of 2013, bitcoins had skyrocketed in value, reaching as much as $750 per bitcoin on the larger exchanges. Due to the meteoric rise in bitcoin exchange rates, a "stack" of bitcoins worth just $667 at the start of 2013 would have gained enough value by year end to trigger FBAR and FATCA reporting requirements.
FBAR Reporting of Foreign Financial Accounts
The FBAR regulations originated with the Bank Secrecy Act (BSA) of 1970 (see 31 C.F.R. §§1010.810(g), 1010.350, and 1010.420). Under the FBAR regulations, U.S. persons with a financial interest in, or authority over, bank accounts, securities, or "other financial accounts" located in foreign countries must file a FinCEN Form 114 (formerly Form TD-F 90-22.1) if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year (31 C.F.R. §1010.350(a)).
In the context of the FBAR regulations, "other financial accounts" includes accounts with investment funds or with any business that accepts deposits as a financial agency (31 C.F.R. §1010.350(c)(3)). Currently, there are no licensed bitcoin banks, but there are numerous bitcoin payment services and currency exchanges. Many of these businesses offer bitcoin deposit accounts similar to bank savings accounts: A customer transfers his or her bitcoins to an account with the business, and the business records the customer's balance on its books. The business retains control and custody over the bitcoins held in its customers' deposit accounts. Moreover, bitcoins held in deposit accounts are fungible, so on withdrawal customers are not guaranteed to get back the same bitcoins they deposited.
Some businesses offer online wallets, which are internet-accessible wallets that provide more convenient means of accessing one's private keys than a wallet stored on a home computer. An online wallet is also conceptually like a safety-deposit box used to store backup printouts of combinations to safes located elsewhere. When a customer transfers copies of his or her private keys to an online wallet, he or she does not transfer any bitcoins. Thus, a customer who retains copies of the private keys may continue to access his or her bitcoins without ever using the online wallet.
In "Application of FinCEN's Regulations to Persons Administering, Exchanging, or Using Virtual Currencies," issued March 2013, the U.S. Treasury Financial Crimes Enforcement Network (FinCEN) stated that any business that transfers virtual currencies, or that exchanges virtual currencies for real currencies, would be considered a money transmitter for registration and reporting purposes under the BSA. Under that guidance, these bitcoin payment services and currency exchanges should be regarded as financial institutions for FBAR purposes. As of March 2014, the largest bitcoin exchanges were located in foreign countries: BTCChina in China, Mt. Gox in Japan (Mt. Gox filed for bankruptcy protection and suspended its website in February), BitStamp in Slovenia, and BTC-e in Bulgaria. Each of these exchanges offers bitcoin deposit accounts to hold bitcoins purchased on the exchange and bitcoins held for sale on the exchange. Thus, a U.S. individual storing bitcoins with any of these exchanges should be subject to the FBAR reporting requirements if the value of his or her bitcoin holdings exceeded $10,000 at any time during the year.
Some foreign bitcoin businesses, such as blockchain.info (located in the U.K.), offer online wallet services but do not otherwise provide financial services. As previously discussed, an online wallet merely stores copies of private keys for accessing bitcoin addresses-the user of the online wallet does not need to use the online wallet, or the copies of the private keys it contains, to access his or her bitcoins. An online wallet service never has control or custody over its users' bitcoins. Consequently, an online wallet service should not be considered a money transmitter and thus should not be a financial institution for FBAR purposes. Thus, a U.S. individual using a foreign online wallet should not be subject to FBAR reporting requirements.
Beginning in 2014, several U.S. and foreign investment companies will offer bitcoin investment vehicles, such as exchange traded funds (ETFs). Under the FBAR regulations, investments in these vehicles may be treated as securities accounts or as investment fund accounts, depending on how they are structured (31 C.F.R. §§1010.350(c)(2) and (3)(iv)(B)). Consequently, U.S. investors in foreign bitcoin ETFs should also be subject to FBAR reporting requirements if the $10,000 value threshold is met.
Individuals subject to FBAR reporting requirements should electronically file FinCEN Form 114 describing their foreign bitcoin holdings by June 30 of the following year (31 C.F.R. §1010.306(c)). A failure to file may cause an individual to incur a penalty of up to $10,000 for nonwillful failures, or up to $100,000 or 50% of the balance in the account for willful failures.
Currently, bitcoin deposit accounts should not be characterized as bank accounts or securities accounts, so the individual should briefly describe the nature of the account in the space provided on Parts II or III of the Form 114 (31 C.F.R. §§1010.100(d) and (ss)). The instructions also provide that the individual should estimate and report the maximum U.S. dollar value of the currency in his or her financial accounts, presumably including bitcoin deposit accounts, during the year using the exchange rate at the end of the calendar year. The bitcoin-U.S. dollar exchange rate differs between exchanges, sometimes dramatically, so the individual should use the exchange rate(s) for the exchange(s) with which he or she had deposit accounts during the reporting year.
FATCA Reporting of Foreign Financial Assets
In addition to the FBAR reporting requirement, U.S. individuals with at least $50,000 of foreign financial assets at the end of the tax year are also subject to FATCA reporting obligations and generally must report these assets on Form 8938, Statement of Specified Foreign Financial Assets (Secs. 1471-1474 and 6038D). The penalty for failure to file is generally $10,000 and may increase to up to $50,000 for continuing failures to file.
Foreign financial assets subject to FATCA reporting include financial accounts with any foreign financial institution (Sec. 6038D(b)). In the FATCA context, "financial institution" includes entities that accept deposits in the ordinary course of a banking or similar business, hold financial assets for the account of others, or engage in the business of trading securities or commodities (including investment vehicles such as mutual funds or hedge funds) (Sec. 1471(d)(5)). For FATCA purposes, the term "financial accounts" includes any depository or custodial account a financial institution maintained (Sec. 1471(d)(2)(A) and (B)).
Most of the bitcoin exchanges discussed above accept deposits in the ordinary course of business. Thus, bitcoin exchanges should be characterized as financial institutions for FATCA purposes. Bitcoin investment vehicles engage in the business of holding financial assets for the accounts of others and/or trading in digital currency securities and should similarly be characterized as financial institutions for FATCA purposes.
Bitcoin deposit accounts are similar to bank deposit accounts and should probably be characterized as financial accounts for FATCA purposes. Bitcoin deposit accounts should be reported in the summary information in Part I of Form 8938, and specific information about the deposit account should be provided in Part V. In Part V, the taxpayer should report the account number or "other designation" for the deposit account, such as the login identification (but not the password) used to access the deposit account. Individuals who traded bitcoins during the year should also fill out Part III, reporting the gains or losses arising from their bitcoin trades. As previously discussed, online wallets are generally not similar to financial accounts and should not need to be reported for FATCA purposes.
Form 8938 is attached to the taxpayer's return, so individuals who are not otherwise required to file a return are not required to file a Form 8938.
Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Bethesda, Md.
For additional information about these items, contact Mr. Anderson at 301-634-0222 or email@example.com.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.