Virtual Currency Exchange Accounts, Hosted Wallet Services, and Vault Services Located Abroad May Trigger FBAR Filing Requirements

By:
Keith Miller, Richard Peterson and Joseph Cutler
Published Date:
Feb 1, 2015

This article is a follow up to “Dealing with Virtual Currency? Taxation, Reporting FBARs, and FATCA Worries,” which appeared in the January 2015 Tax Stringer.

As the title suggests, there remains an open question as to whether virtual currency accounts, hosted wallet services and vault services located abroad may trigger FBAR filing requirements. Based on case law and the probability of FinCEN deciding to treat virtual currency the same as money, it appears likely that the FBAR filing requirements applicable to monetary accounts will also be applied to accounts funded with virtual currency.

Generally, one way the Bank Secrecy Act (“BSA”) protects against laundering money through foreign financial institutions is to require United States persons (a term that includes natural persons, most legal entities, and trusts and estates) to file Foreign Bank and Financial Accounts Reports (“FBARs”), Form 114 (the most recent version released on September 30, 2013 available at http://bsaefiling.fincen.treas.gov/main.html). FinCEN and the IRS work in conjunction to ensure that FBARs are filed. Although the IRS has the authority to examine and enforce FBAR filings, the FBAR filing requirement is not a tax filing.

The failure to file FBAR penalties are onerous. The deadline for FBARs to be filed with the Department of the Treasury is on or before June 30 following the calendar year being reported. There are no extensions with severe civil and criminal penalties for failure to file. The willful failure to file penalty can result in a civil penalty as high as the greater of $100,000 or 50% of the total balance of the foreign account per violation as well as potential criminal penalties under U.S. tax law.

An FBAR return must be filed by a United States person if:

(1) they have a financial interest (i.e., owner of record or holder of legal title by the U.S. person or their agent or representative or having a sufficient interest in an entity that is the owner or record or holder of legal title) or signature authority (the authority to control disposition of account assets by direct communication with the financial institution maintaining the account) over at least one financial account in a foreign country (physically located in a foreign country), and

(2) the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year (subject to a number of exceptions).

Each foreign financial account must be valued separately at its highest annual value, using periodic account statements to determine the maximum value in the currency of the account and converting that value to U.S. dollars using the end of the calendar year exchange rate.

So with respect to virtual currency, is a “wallet” or other similar account a “financial account?” For FBAR filing requirement purposes, the regulations define a “financial account” to include an account with a person in the business of accepting deposits as a financial agency. While the term “financial agency” is not defined by the relevant statute, the regulations define the term “foreign financial agency” as “a person acting outside the United States for a person . . . as a financial institution, bailee, depository trustee, or agent, or acting in a similar way related to money, credit, securities, gold or a transaction in money, credit, securities, or gold.” Bitcoins clearly are not gold, and are unlikely to be credit or securities, but they could easily be treated as money. While the term “money” is not defined in the BSA, FinCEN has interpreted a “money transmitter” to include administrators or exchangers of decentralized virtual currency.

While wallets are not the same as bank accounts and are subject to different rules and procedures, they may nonetheless be considered to be “financial accounts.” In United States v. Hom, 113 A.F.T.R.2d 2014-2325 (N.D. Cal. 2014), a U.S. taxpayer who played poker online kept money for playing on deposit at several different online sites. The IRS asserted the money held by the companies operating these poker sites was a “financial account.” The court agreed, stating:

While our court of appeals has not yet answered what constitutes “other financial account[s]” under 31 C.F.R. [1010.350], the Court of Appeals for the Fourth Circuit found that an account with a financial agency is a financial account under Section 5314. Clines, 958 F.2d at 582. Under Section 5312(a)(1), a “person acting for a person” as a “financial institution” or a person who is “acting in a similar way related to money” is considered a “financial agency.” Section 5312(a)(2) lists 26 different types of entities that may qualify as a “financial institution.” Based on the breadth of the definition, our court of appeals has held that “the term ‘financial institution’ is to be given a broad definition.” United States v. Dela Espriella, 781 F.2d 1432, 1436 (9th Cir. 1986). The government claims that FirePay, PokerStars, and PartyPoker are all financial institutions because they function as “commercial bank[s].” Section 5312(a)(2)(B). The Fourth Circuit inClines found that “[b]y holding funds for third parties and disbursing them at their direction, [the organization at issue] functioned as a bank [under Section 5314].”Clines, 958 F.2d at 582.

The court further concluded that the deposit accounts in question were digital constructs that these financial institutions, all located outside of the United States, created and maintained on the taxpayer’s behalf.

Thus, in view of the court’s analysis, FinCEN and the IRS may decide to treat Bitcoin (a digital construct) as money for purposes of FBAR filing requirements. And, because a “money transmitter” is considered a “financial institution” under BSA regulations, it would not be a stretch to conclude that an administrator, exchanger, or bailee of a decentralized virtual currency would be considered a “financial institution.”

Unless FinCEN or the IRS take a contrary position it is likely that a United States person would be required to file FBARs if such person maintains deposits of virtual currency in an amount equivalent to $10,000 in aggregate over the course of a year with foreign exchanges or uses hosted wallet services or vault services operated by foreign entities to store that amount of virtual currency. This is because pursuant to the BSA, FinCEN and the IRS would characterize those services as “financial institutions,” and the accounts holding the virtual currency as financial accounts in a foreign country over which the United States person has a financial interest and/or signatory authority. Also, it is obvious that United States persons with $10,000 or more in aggregate value over the course of a year in real currency with a foreign virtual currency exchange would trigger the FBAR filing requirement.

It should be noted that any IRS guidance with respect to requiring the filing of FBARs for virtual currency will likely be presented in the same context as Notice 2014-21, in which the IRS characterized virtual currency as property, (i.e., as a clarification and not a new interpretation of existing law). Thus, the application of penalties will be less certain, especially given the onerous nature of penalties for willful failure to file FBARs. Due to heightened scrutiny of both foreign and domestic virtual currency transactions and transmissions, United States persons dealing with virtual currency who fail to FBARs as required are increasingly likely to be discovered by the U.S. government.

There is, however, a voluntary disclosure program, or amnesty program, applicable to FBAR filings (more information available at http://www.irs.gov/uac/2012-Offshore-Voluntary-Disclosure-Program). Although the program is generally open-ended, it may be terminated by the IRS at any time. Under the current program, reduced penalties are still available for some taxpayers who participate, but the penalties have been increased if the IRS catches the taxpayer.

United States Persons Holding Virtual Currency with an Aggregate Value of $50,000 or More at the End of the Tax Year, or $75,000 at Any Time During the Tax Year Must Also Report Under the FATCA

The United States exerts significant pressure on foreign financial institutions to identify their U.S. clients to U.S. authorities. The Foreign Account Tax Compliance Act (“FATCA”) is one method used by the U.S. government to exert such pressure. Under FATCA, to avoid penalty, foreign financial institutions (that with some exceptions include banks, mutual funds, hedge funds, private equity funds and certain types of insurance companies which offer cash value or annuity products) must register with, and report information about their U.S. customer accounts, to the IRS. Foreign financial institutions that fail to register risk the imposition of withholding on certain payments owed to them by registered foreign financial institutions. Thus, unless the foreign recipient can provide the proper documentation that it has no U.S. investors, payments made to non-U.S. persons with virtual currency may be subject to the portions of FATCA that impose withholding even where none is otherwise required. What constitutes the proper documentation will depend in large part on the country in which the foreign recipient resides.

In addition to requiring participating foreign financial institutions to relay information regarding financial accounts held by U.S. taxpayers to the IRS, FATCA also requires U.S. taxpayers holding foreign financial assets with an aggregate value in excess of $50,000 at the end of the tax year or $75,000 at any time during the tax year to report the same to the IRS by attaching Form 8938, the Statement of Specified Foreign Financial Assets, to the individual’s income tax return. This requirement is in addition to an FBAR filing. Unlike an FBAR filing, however, if a U.S. taxpayer has signatory authority on a foreign financial account, but only indirect interests in the foreign financial assets held there through an entity, a Form 8938 is not required. On the other hand, unlike FBAR filing requirements, foreign stock or securities not held in a financial account and foreign partnership interests must be reported if they meet the FATCA requirements.

A U.S. taxpayer required to file Form 8938 who does not file it completely and correctly by the due date (including extensions) may be subject to a $10,000 penalty. Moreover, a taxpayer who receives a IRS notice of failure to file and does not correct and complete Form 8938 within 90 days of the notice date may be subject to an additional penalty of $10,000 (up to a maximum of $50,000) for each 30-day period (or part of a period) after the 90-day period has expired in which the Form 8938 remains unfiled. Please note that these penalties are in addition to any penalties applicable to failure to file an FBAR.

This article should not be construed as providing legal advice, but rather as an attempt to identify certain tax issues associated with virtual currency.


Keith MillerKeith Miller is a partner with Perkins Coie’s Litigation practice and firmwide Chair of the White Collar & Investigations practice. Mr. Miller is a former SEC enforcement attorney whose practice focuses on investigations and white collar crime matters, as well as complex civil litigation. His clients have included some of the world's leading financial institutions, including investment banks, and broker-dealers. He frequently represents these clients in civil litigation and in connection with investigations being conducted by various federal and state agencies, including the SEC, Department of Justice, Financial Industry Regulatory Authority, and Commodity Futures Trading Commission. Mr. Miller has recently represented clients in several high-profile litigations and investigations involving virtual currencies and decentralized crypto-currencies. He can be reached at: KeithMiller@perkinscoie.com. 

Richard PetersonRichard Peterson, a partner with Perkins Coie’s and firmwide Chair of the Federal Tax practice, has experience in a wide variety of matters including taxation of mergers, acquisitions and divestitures, partnership taxation and international taxation. He is experienced in partnership tax planning, including structuring venture capital funds (both U.S. and international) and advising potential investors. Mr. Peterson has worked on mergers, acquisitions and divestitures including taxable and tax-free transactions with both asset and stock acquisitions. He also has significant tax litigation experience covering all aspects of IRS controversy work from audits and appeals work through litigation before the U.S. Tax Court. He can be reached at: RPeterson@perkinscoie.com.

Joseph CutlerJoseph Cutler is counsel in Perkins Coie’s Privacy & Security practice, providing advice related to data privacy and security, consumer protection, and Internet law. His litigation practice focuses on combating cybercrime and enforcing website terms of use where he manages a rapid response enforcement team to defend clients, such as Facebook, against illegal spamming, phishing, pretexting, and other forms of malicious Internet behavior. In addition to his litigation work, Mr. Cutler represents a range of companies in the emerging financial technology and virtual currency industry, designing their anti-money laundering programs, representing them before regulators, and providing compliance advice. He can be reached at: JCutler@perkinscoie.com.

 
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