Recent news about the IRS and bitcoin is disturbing enough, but it is the tip of an iceberg known as FATCA. American bitcoiners should be aware that their transactions of the past few years could endanger them.
Also read: IRS Demands Coinbase Records In Surprise Tax Probe
IRS Sets It’s Sights On Bitcoin Users
The visible news: On November 18, a headline at Coindesk announced, “The IRS is Seeking Data on Coinbase’s Bitcoin Customers.” The article stated, “it seems, the IRS is looking to more aggressively police digital currency users in the US, and the [tax] investigation itself focuses on taxpayers who transacted between 2013 and 2015.” The investigation rests on a “John Doe” warrant. The “John Does” of interest are Americans who use bitcoin to evade tax reporting and payment requirements. The goal is almost certainly to audit non-compliers. Unfortunately, since the focus is on past transactions, a proactive response is difficult.
Currently, the matter is on hold. A Coinbase customer has filed suit to block IRS access to records, but the suit is unlikely to prevail; the IRS wins 90% of such cases. Coinbase is also resisting the IRS, but it will almost certainly comply under a court order. The brake on the IRS is not likely to last.
Meanwhile, a key aspect of the IRS demand is under-discussed. The agency clearly wants to extend the Foreign Account Tax Compliance Act (FATCA) to cover bitcoiners.
What Is FATCA?
Enter FATCA. Passed in March 2010, FATCA imposes extensive requirements on foreign banks and financial institutions to report on the accounts and transactions of American clients. It does not target individuals but institutions. Or, rather, it targets individuals by strong-arming institutions to provide open access to their accounts.
A sense of how aggressive FATCA is can be gleaned from its sweeping definitions.
For example, the definition of an American with tax liability includes ‘accidental Americans.’ These are people who might have never set foot on U.S. soil but have at least one American parent and so are considered dual citizens. Thus, Canadian-born Ted Cruz could run for President because his mother was American. An estimated 1 in 20 Canadians are either American transplants or accidental Americans. Those classified as American by FATCA are legally required to file returns and pay whatever taxes the IRS proscribes for foreign assets; it doesn’t matter if taxes are being paid to the foreign government as well.
The definition of a foreign financial institution is equally broad. The standard one is “[a]ny foreign entity that: Accepts deposits in the ordinary course of banking or a similar business such as banks and credit unions. Holds financial assets for the account of others as a substantial portion of its business such as brokerages or custodians.” It currently includes security brokerages and could easily be expanded to include bitcoin institutions such as exchanges.
It is technically true that the U.S. cannot compel foreign institutions to obey IRS regulations. But powerful ‘incentives’ are in place. For example, the U.S. threatens to withhold up to 30% of any U.S. security transaction from a noncomplying bank.
In Forbes (October 19), tax attorney Robert W. Wood explained:
Non-compliant institutions are frozen out of U.S. markets, so there is little choice but to comply. FATCA cuts off companies from access to critical U.S. financial markets if they fail to pass along American data. More than 100 nations have agreed to the law. Countries must agree to the law or face dire repercussions.
FATCA almost certainly wants to plunder the untapped wealth of the bitcoins owned or traded by “United States persons.” The first ones targeted will be natural-born Americans, who are low-lying fruit; those who are more difficult to track, such as accidental, Americans are likely to be next. And the first step in uncovering all of them is to demand compliance from the financial institutions of cryptocurrency, such as Coinbase.
Indications That FATCA Will Strike
Several compelling indications exist. Two are particularly significant.
A FATCA that targets the financial institutions could become an effective enforcement mechanism – that is, if the institutions comply. Again, the enforcement will undoubtedly start in the United States. But, given the agility with which digital currencies can flee across borders, the IRS is likely to swiftly go after foreign exchanges in the same manner as it went after banks.
A November 13, 2014, Bloomberg article, entitled “Bitcoin Accounts May Be Subject to FBAR, FATCA Reporting,” stated,
Eventually, experts said, it is even possible that the foreign exchanges themselves may be considered foreign financial institutions (FFIs) that have to report the accounts to the IRS under…FATCA.
The “eventually” seems to be arriving. Indeed, the process has been unfolding for over a year now. Bitstamp, which has offices in the UK and Luxembourg as well as America, states in its Terms of Use:
With respect to US residents, we also may share your information with other financial institutions as authorized under Section 314(b) of the US Patriot Act, and with tax authorities, including the US Internal Revenue Service, pursuant to the Foreign Account Tax Compliance Act (“FATCA”), to the extent that this statute may be determined to apply to Bitstamp Ltd. “Personal Information” refers to information that identifies an individual, such as name, address, e-mail address, trading information, and banking details.
In the big picture, the IRS’s attempt may be unsuccessful because of the unique nature of cryptocurrencies. In the smaller picture, however, the brute force of its attack could devastate many individuals.
Second, on November 18, 2016, a court document “had detailed testimony in support of issuing the summons” against Coinbase. Daniel Winters, a specialist in cryptocurrency taxation, recently pointed to a rather ominous aspect of that document.
The IRS agent who wrote the declaration is extremely experienced regarding offshore arrangements to avoid paying taxes. He works in the Offshore Compliance Initiative, an IRS program the purpose of which is finding taxpayers who have hidden money offshore and avoided paying their taxes. The agent is now assigned to find taxpayers that used bitcoin to avoid paying taxes.
Winters also pointed to the IRS agent’s past involvement in auditing a taxpayer and two corporations who used offshore “arrangements” to avoid taxes. Winters commented, “[t]he IRS audit did not go well for the taxpayers.”
Conclusion
Americans or “United States persons” who have used financial institutions, such as exchanges, for their bitcoins should be aware that the past few years worth of transactions are vulnerable to IRS scrutiny. Winters advised, “You may not be informed if your records are sent to the IRS, and may find out only when you receive a nasty letter from the IRS demanding payment of the tax due on the bitcoin income.”
If there is a solution to this situation, bitcoiners had best forge it now.
What do you think about the IRS targeting U.S. bitcoin users? Let us know in the comments below.
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