U.S. Taxation of Cryptocurrencies – International Considerations

U.S. taxpayers are required to report gross income from wherever and whatever source derived, including cryptocurrency transactions. Cryptocurrency, also referred to as crypto, is, per the IRS, “a digital representation of value that functions as a medium of exchange.” For all intents and purposes, crypto is an electronic payment system that is based on cryptographic proof, allowing parties to exchange the crypto using blockchain technology.

Blockchain does not require a third-party intermediary to validate the transaction but instead permits participants to confirm transactions via a decentralized ledger. Participants who successfully validate a transaction through a process referred to as “mining” are rewarded with cryptocurrency. Because blockchains utilize a peer-to-peer network, as opposed to a centralized authority, they cannot be controlled by any single company, government, or person, which is one of the reasons this technology has so much potential for use.

In short, crypto has become an important addition to the global economy. Its value and use are of increasing interest to the U.S. Internal Revenue Service (IRS) and corresponding state tax agencies, the Department of Treasury, the Securities and Exchange Commission (SEC), and the Financial Crimes Enforcement Network (FinCEN) on both income and information reporting fronts.

While the U.S. income tax reporting of crypto transactions is ostensibly settled, i.e. virtual currency is treated as property and is reported as such, the international information reporting considerations for crypto are less clear.

International Information Reporting

The IRS and the Department of the Treasury require taxpayers to disclose their foreign accounts and assets on the Foreign Bank Account Report (FBAR) Form and Form 8938 – Statement of Specified Foreign Financial asset forms, respectively.

Both forms were designed to track foreign financial accounts and assets to prevent tax evasion and money laundering. Neither form carries any tax implications – they are for information reporting purposes only.

The FBAR form was brought into practice as part of the Bank Secrecy Act enacted in 1970, while Form 8938 made its debut for the 2011 tax year.

The FBAR form is limited in scope as it applies to “financial interests” in a “foreign financial account,” and only if the combined maximum values of all accounts are more than $10,000. Form 8938 covers a larger territory requiring reporting of “specified foreign financial assets” which are more than just foreign accounts. It seems that the IRS required an even deeper look into U.S. taxpayers’ international assets, and the FBAR form was too limited for IRS purposes – enter FATCA.

FATCA, or the Foreign Account Tax Compliance Act, was regarded as one of the most invasive acts enacted to uncover those hiding money offshore and evading taxes. Not only did it require U.S. taxpayers to report additional assets, but it also required foreign governments to report to the IRS information on U.S. account holders. As there were complex banking laws already in place in these foreign jurisdictions, the reporting for these “normal” financial institutions was no problem.

What happens, however, when a taxpayer holds crypto on a non-U.S. exchange or via a wallet?

Foreign Bank Account Report Form

In Notice 2020-2 FinCEN acknowledged that the FBAR regulations do not define a foreign account holding virtual currency as a type of reportable account. That account would only be reportable if it holds both virtual currency and other reportable assets.

In the same notice, however, FinCEN made it clear that it intends to propose an amendment to the regulations amending the Bank Secrecy Act regarding the FBAR form to include virtual currency as a type of reportable account.

The IRS is gearing up for this change, as there is now the inclusion of a question on Form 1040 – Individual Income Tax Return asking if the taxpayer or spouse received, sold, exchanged, or otherwise disposed of any financial interest in virtual currency during the tax year.

Some may remember this is how FBAR enforcement started – with a simple checkbox.

Wolf’s Interpretation Regarding FBAR Reporting

For the time being, the reporting requirements are clear – the FBAR regulations do not define a foreign account holding only virtual currency as a type of reportable account. The writing is on the wall, however; the shift to reporting crypto has started.

At Wolf we interpret this notice as referencing foreign held crypto wallets only, rather than other traditional foreign accounts holding crypto. If that traditional foreign account holds crypto only, we believe this would be a reportable account for FBAR purposes.

Form 8938 – Statement of Specified Foreign Financial Assets

The IRS has not yet made any official policy updates that would mandate reporting of crypto on the Form 8938, so we are left without guidance. With that said, a look at the underlying statutes and regulations supporting the reporting on the Form 8938 is needed to determine if current reporting of crypto is required.

The underlying statutes and regulations focus on two types of “specified foreign financial assets.” These include:

  • “Financial accounts” maintained by “foreign financial institutions.”
  • Assets held for investment but not held in an account, namely stock or securities issued by a non-U.S. person, any financial instrument or contract held for investment that has an issuer or counterparty that is not a U.S. person, or any interest in a foreign entity.

Further, a “foreign financial institution” is defined as an entity that:

  • Accepts deposits in the ordinary course of banking or a similar business or
  • As a substantial portion of its business, holds “financial assets” for the account of the others or
  • Is engaged (or holds itself out as being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership interests, commodities, or any interests in such securities, partnership interests, or commodities.

Based on the above, it would not appear that crypto meets these parameters for reporting. While an official policy update is lacking, an IRS official replied to a question asking whether the IRS will assess penalties against taxpayers who haven’t been disclosing digital assets on Form 8938. The official stated that if taxpayers had been reporting taxable cryptocurrency transactions on their returns during prior years and properly filed Form 8938 going forward, the IRS probably would not pursue them for prior tax years.

Wolf’s Interpretation Regarding Form 8938 Reporting

The reporting on Form 8938 is unclear at this stage.

The IRS is certainly starting to connect the dots on crypto transactions – Form 1040 includes a yes or no question on the front page of the return and there are the John Doe summons at issue in U.S. v. Coinbase.

While these information gathering occurrences cannot be ignored, the fact of the matter is that the IRS considers crypto to be property, not a commodity or security, and this distinction is key as crypto does not appear to meet the parameters for Form 8938 reporting.

The conservative approach is clearly to report the crypto on Form 8938 if it is not held on a U.S. exchange. Will the nonreporting be seen as willful behavior akin to that of FBAR noncompliance? Only time will tell.

How Can We Help?

Wolf’s International and Cryptocurrency Tax Teams are closely following the market trends in the cryptocurrency and digital asset environment as well as relevant legislation and guidance at the federal and state level. If you are a taxpayer or tax preparer/advisor who has questions related to the above topics, please reach out and we’d be happy to discuss you or your clients’ needs.