Reporting requirements that every estate planner should know.
Jeopardy! Answer: It has no filing fee, no associated tax, but if you don’t report your Bitcoin on it, you may lose half your account. Question: What is the Foreign Bank Account Report (FBAR)?
If you or your clients have been investing in cryptocurrencies, you might be surprised to hear that Bitcoin and other cryptocurrencies may be reportable on the FBAR. In fact, if you’ve heard elsewhere that cryptocurrencies don’t belong on the FBAR, you’re not alone. A quick search of the Internet shows national confusion on this question,1 and the Internal Revenue Service hasn’t offered guidance yet. The IRS has confirmed that income and gains from cryptocurrency transactions must be reported on income tax returns, but there’s no official position as of the date of this writing regarding FBAR reporting.2 The bad news is that taxpayers may have a duty to report, and the IRS may enforce that duty, even though the duty hasn’t been expressly announced.
There’s some good news. Since there’s no tax associated with the FBAR, our clients may avoid the risk of penalties by reporting all cryptocurrency if they exceed the FBAR filing threshold. For clients who prefer to take a more nuanced approach, existing law provides further guidance.
FBAR and Estate Plans
Because we estate planners advise individual clients about wealth, we know many of the issues and challenges associated with different types of assets. Alongside our repertoire of knowledge about retirement accounts, precious metals, art and insurance, we should know some of the issues associated with owning foreign accounts. Spotting an FBAR issue can add real value to our services because penalties for failing to report foreign accounts can be as high as half of the account balances. If we don’t help our clients avoid these penalties, they may ask us later why we didn’t know or why we didn’t tell them.
The FBAR filing requirement has been in effect for decades,3 but many advisors are still unfamiliar with it. Any client with more than $10,000 in one or more accounts outside the United States must report each such account annually on the FBAR.4 For example if a client has three foreign accounts, one with $8,000, one with $2,000 and one with $1, then all three accounts must be reported on the FBAR because the taxpayer has exceeded the $10,000 threshold. The FBAR is due April 15 each year, and under current guidelines, there’s an automatic extension to Oct. 15.5 If a U.S. taxpayer doesn’t report foreign accounts on a timely filed FBAR, the taxpayer risks penalties. The IRS can only assess FBAR penalties after an examination, but the penalties are a serious concern because they can range from $10,000 per account, per year, up to half of the account balance, depending on the taxpayer’s “willfulness.”6 Penalties can be avoided completely if a taxpayer has “reasonable cause” for failing to file.
Here are a few common client situations that raise FBAR issues: (1) A U.S. resident worked 20 years ago in Australia and has an Australian retirement account worth $13,400; (2) A U.S. citizen and resident owns a cabin in Canada and keeps a small bank account to pay expenses. The account held $15,000 for a few weeks last year because the client did some major repair work; (3) A U.S. client inherits non-U.S. money or property; and (4) Now, as explained below, it may raise FBAR issues if a U.S. resident trades $10,000 of Bitcoin on a non-U.S. exchange.
Reportable Foreign Account
Generally, a taxpayer must report “a financial interest in, or signature or other authority over, a bank, securities, or other financial account in a foreign country.”7 That is, the FBAR is used to report a U.S. individual’s relationship with any foreign financial agency. If a cryptocurrency exchange is a foreign financial agency, or if a cryptocurrency wallet is a “financial account” located outside the United States, then all amounts held with that exchange, or in that wallet, are reportable on the FBAR.
Virtual currency providers and hosts may fall into the category of providing “financial accounts” by offering any one of the following services: accepting deposits as a financial agency, providing insurance or annuity policies with cash values, providing mutual funds or similar pooled funds or conducting futures or options transactions for any commodity that’s subject to the rules of a commodity exchange or association.8 Foreign companies that provide virtual currency services can easily fall into one or more of these categories.
Offshore Gambling Accounts
Some non-U.S. accounts holding cybercoins or tokens may be reportable on the FBAR, and others may not. In U.S. v. Hom, an unpublished decision by the U.S. Court of Appeals for the Ninth Circuit, the IRS argued that several non-U.S. accounts relating to virtual poker tokens were subject to FBAR reporting. The taxpayer purchased virtual poker tokens through a U.K. intermediary company. He sent money from his bank account to the intermediary U.K. account, which was an online payment service. From that intermediary online account, he purchased tokens on two separate non-U.S. poker websites. The U.K. intermediary allowed the taxpayer to carry a balance on his account, and it charged him a transaction fee for issuing poker tokens.9
The Ninth Circuit reviewed the facts in Hom and concluded that the intermediary account was reportable on the FBAR, but the accounts on the two poker sites weren’t. The court concluded that the intermediary company converted currency into poker tokens and performed several other services that were similar to banking services. Therefore, that intermediary account was reportable. The accounts with the poker companies weren’t reportable. The poker companies were engaged in the business of running poker games, and the court concluded that business activity wasn’t similar to banking services.
Following the logic applied in Hom, U.S. taxpayers should consider reporting virtual currency on the FBAR if that currency is held in an account with a financial agency located outside the United States.
Because the Hom decision is unpublished and because the IRS applied reporting penalties to Hom’s in-game poker accounts, U.S. taxpayers may consider reporting all non-U.S. virtual accounts on the FBAR. This includes token holdings on poker sites and even cash balances in foreign games, if the total of all non-U.S. balances exceeds $10,000 at any time during the calendar year. This conservative reporting stance could protect taxpayers from penalties in the event of audit.
Commodity?
One might argue that cryptocurrency is a commodity, like gold, and therefore, it isn’t reportable as an “account” on the FBAR. However, contrary to popular belief, the IRS indicates that commodities may be reportable on the FBAR. The Internal Revenue Manual provides that “a reportable account relationship may exist where a foreign agency holds precious metals on deposit or provides insurance or other services as an agent of the person owning the precious metals.”10 By analogy, if cryptocurrencies are commodities, then any virtual wallet may constitute a reportable “account,” particularly if it’s an insured wallet or if the cryptocurrency broker provides other services that are equivalent to banking services.
There’s support for the argument that virtual currencies are commodities. After all, the U.S. Commodity Futures Trading Commission (CFTC) attempts to regulate cryptocurrency as a commodity. A federal judge recently agreed that the CFTC had regulatory authority in a cryptocurrency case.11 Therefore, commodity reporting requirements may apply to virtual currencies.
Securities?
In addition to being treated as commodities, cryptocurrencies might simultaneously be securities. The Securities and Exchange Commission (SEC) has indicated that initial coin offerings (ICOs) may be offerings of securities. In at least one case, the SEC has found that a platform offering an ICO was an “exchange,” and the coins or tokens traded on that exchange were securities.12 The details of how the SEC regulates ICOs are outside the scope of this article, but any reader with interest in this topic should read the SEC’s “Statement on Cryptocurrencies and Initial Coin Offerings.”13
If the IRS agrees with the SEC that coins and tokens themselves are securities, then taxpayers will need to report accounts with non-U.S. companies in which taxpayers hold and exchange cryptocurrencies.
In addition to the coins themselves, derivative instruments exist for cryptocurrencies. For example, a taxpayer might own futures, options or warrants in cryptocurrencies. By their nature, these instruments likely are securities, and if they’re offered by a non-U.S. company or held in an account with a non-U.S. company, they’re likely subject to FBAR reporting requirements. Additionally, any U.S. investments in crypto “funds” offered by non-U.S. companies may be subject to the punitive Passive Foreign Investment Company rules.14
Using Foreign Transfer Agents
Applying Hom, it’s important to note that even one transaction through a foreign transfer agent could trigger FBAR reporting. The amount that must be reported on the FBAR is the highest balance in an account at any time during the year. There’s no minimum time period during which the account must exist. Therefore, funds that simply pass through a foreign intermediary may be reportable on the FBAR, especially if the intermediary maintains some kind of account for the U.S. taxpayer.
Bottom Line
Consider the following:
• If a taxpayer holds or exchanges virtual assets through a foreign company at any time during a year, and if the taxpayer meets the $10,000 FBAR reporting threshold, then consider reporting those assets on the FBAR.
• If the taxpayer is below the FBAR filing threshold even when taking the virtual currency into account, the FBAR isn’t required. However, remember that the FBAR applies if the threshold is met at any time during the reporting year. Because cryptocurrency values tend to fluctuate widely, obtaining the highest balance in a year may be a challenge.
• If all the taxpayer’s virtual wallets or accounts are with U.S. companies, the accounts likely aren’t “foreign” and therefore wouldn’t need to be reported on the FBAR. The FBAR only applies to “foreign” accounts, and the underlying statute refers to a foreign company that provides banking services.15 Even though virtual currencies may be mined and stored on servers worldwide, the nexus for FBAR reporting likely will come from the location of the company providing the wallet, insurance or other financial agency services. However, all other tax reporting obligations would apply to the income, gains and losses on the accounts whether they’re located in the United States or abroad.16
• Because the FBAR reporting requirements are so unclear, taxpayers may choose to report all their virtual accounts on the FBAR. After all, there’s no tax associated with the FBAR, but there can be hefty penalties for failing to report an account that the IRS later determines to be reportable. Timely and comprehensive filing can prevent all penalties.
Endnotes
1. www.cnbc.com/2018/04/09/how-cryptocurrency-investors-could-find-themselves-behind-bars.html(quoting advisors saying there “probably is” a reporting requirement and that a foreign exchange produces a reportable account); www.forbes.com/sites/greatspeculations/2018/01/29/separating-myth-and-reality-of-how-cryptocurrencies-are-taxed-and-regulated/#6b4c64c920cc (saying the Internal Revenue Service has “informally stated” that cryptocurrency isn’t reportable on the Foreign Bank Account Report (FBAR)); www.bna.com/bitcoin-exchange-accounts-n17179891170/ (applying U.S. v. Hom and concluding that all coins held or exchanged through Mt. Gox, a Japanese company, should be reported on the FBAR).
2. IRS Notice 2014-21. The IRS hasn’t responded to my telephone calls regarding the reporting of cryptocurrency on the FBAR.
3. Statutory authority for the FBAR reporting requirement comes primarily from the Bank Secrecy Act of 1970, PL 91-508, and 31 U.S.C. Section 5314 (1982).
4. See the instructions to FinCEN Form 114, www.fincen.gov/sites/default/files/shared/FBAR%20Line%20Item%20Filing%20Instructions.pdf.
5. See FinCEN Due Date Clarification PD 02-02-2018, www.fincen.gov/sites/default/files/shared/FBAR_Due_Date_Clarification_PD02-02-2018.pdf.
6. See, e.g., United States v. Bussell, 2015 WL 9957826, affirmed on appeal, 699 Fed.Appx. 695 (Mem).
7. 31 C.F.R. Section 1010.350(a).
8. 31 C.F.R. Section 1010.350(c)(3).
9. U.S. v. Hom, No. 14-16214 (9th Cir. July 21, 2016).
10. Internal Revenue Manual 4.26.16.3.2., Note at 3.d. (Nov. 6, 2015).
11. CFTC v. McDonnell and Cabbagetech, Order dated March 6, 2018, Docket No. 18-CV-361 (U.S.D.C., E.D. NY); see also press release announcing final judgment in favor of the Commercial Futures Trading Commission, www.cftc.gov/PressRoom/PressReleases/7774-18.
12. See“Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934: The DAO,” Release No. 81207 (July 25, 2017), www.sec.gov/litigation/investreport/34-81207.pdf.
13. Statement on Cryptocurrencies and Initial Coin Offerings (Dec. 11, 2017), www.sec.gov/news/public-statement/statement-clayton-2017-12-11.
14. 26 U.S.C. Section 1297.
15. 31 U.S.C. Section 5314.
16. See supra note 2.