How Will the IRS Monitor and Monetize the Elusive Blockchain?
The crypto industry is seeing increasing adoption and explosive growth, clearly evidenced by the ProShares Bitcoin Strategy ETF reaching $1 billion in assets under management in just two days of trading. As more and more investors buy, hold and trade crypto, how are the U.S. regulatory authorities treating digital assets?
FinCEN and Crypto
The main purpose of the U.S. Treasury’s Financial Crimes Enforcement Network, or FinCEN, is to prevent and punish money laundering and related financial crimes. They are the primary Anti-Money Laundering (AML) and Combating Funding of Terrorism (CFT) regulator. Until recently, virtual currencies did not have to be reported on FinCen Form 114, Report of Foreign Bank and Financial Accounts (FBAR.)
For the better part of a decade, FinCEN lacked a clear policy on virtual currencies, but became more active beginning in 2019, issuing the guidance, Regulations to Certain Business Models Involving Convertible Virtual Currencies. A further attempt in 2020 to define categories of digital assets and their ruling agencies failed to gain momentum. So currently, FinCEN, the CFTC and the SEC are all vying to be “the” crypto regulator.
FBAR and Crypto
How does the U.S.Treasury and FinCEN become involved? Following the passage of the Bank Secrecy Law in 1970 to fight money laundering in the United States, various financial reporting obligations to identify and collect evidence against money laundering and criminal activity were created.
One of these obligations is the FBAR, which needs to be completed for any individuals who have a financial interest in or signature authority over any financial account(s) outside of the United States with an aggregate maximum value exceeding $10,000 at any time during the calendar year.
Back in 2014, when cryptocurrencies were still in their infancy, the Internal Revenue Service (IRS) issued guidance, stating, “virtual currency is not treated as currency that could generate foreign currency gain or loss for U.S. federal tax purposes.” In other words, the IRS didn’t mention the FBAR, and FinCEN confirmed that for FBAR purposes, Bitcoin was not reportable.
However, this is all about to change. In June, FinCEN included cryptocurrency in its anti-money laundering national priorities, and in November, will release a regulatory action to require banks and money service businesses (MSBs) to submit reports, keep records, and verify the identity of customers in relation to transactions involving convertible virtual currency or digital assets with legal tender status held in unhosted wallets, or held in wallets hosted in a jurisdiction identified by FinCEN.
FinCEN is also working on rules that would require crypto exchanges to file reports when customers move at least $10,000 of currency to a wallet not hosted at an exchange.
IRS: Caught Between Two Worlds
At present, there are no distinct definitions under IRS tax rules for cryptocurrency, with regards to meeting the current/traditional definition of an investor account or international asset. Reports are not issued to the government as in a regular investment account which issues a 1099. What’s more, the IRS has no idea what coins an account holder owns, or potential income they may accrue.
While investments, such as stocks, mutual funds or ETFs, are held at brokerage firms or banks which are also required to submit account holding information to authorities, coins such as bitcoin or ethereum fall into a gray area. Cryptocurrency can be stored on an exchange, in a digital wallet, or in a hard wallet, which is offline. Outside of exchanges, the other options leave the reporting of cryptocurrency open to the individual’s interpretation.
The IRS is acutely aware of the need to make new rules requiring reporting.from both entities holding the accounts and the account holders themselves. They are working on adding new definitions to current laws, which only address traditional, tangible assets.
Virtual currencies encompass a broad swath of investment and transactional vehicles, including cryptocurrency, stablecoins, NFTs, and other vehicles yet to be created using blockchain technology. New rules from the IRS will need to encompass not only current digital assets, but future variations yet to be invented.
New Rules
The bottom line: If the IRS tries to force FBAR or other reporting, they will have to write rules to go outside traditional assets. This could lead to creativity, as clever folks find ways to use blockchain that avoid easy definition. The IRS will have to make the definition of the asset in relation to being on the blockchain. In other words, if it walks like a duck, swims like a duck and quacks like a duck, it is a taxable, blockchain duck.
The evolution of the U.S. policy on the taxation of digital currency and blockchain-created assets held in foreign or domestic accounts will be avidly followed by world leadership organizations, banks and regulatory agencies, investors and entrepreneurs alike. We look forward to staying on top of all the latest developments and sharing them with you.
