The US Treasury Department is once again sharpening its sword on crypto. In January 2021, the Treasury Department’s Financial Crimes Enforcement Network issued Notice 2020-2. The notice states that FinCEN plans to amend its regulations regarding the reporting of foreign financial accounts to include digital currencies as a type of reportable account.
In simple terms, this means that FinCEN may soon require crypto users to submit annual reports of foreign bank and financial accounts or FBARs for cryptos held on foreign exchanges. The effects of such a change are significant. The notice is only a paragraph long and has several implications affecting crypto owners – well beyond a simple FBAR report.
Currently, cryptocurrency accounts are not reportable accounts within the meaning of the FBAR regulations. Should a change occur, crypto owners – already burdened by an increased focus of the Internal Revenue Service – would then be required to report the highest aggregated balances of their crypto accounts to FinCEN annually.
This requirement is in addition to the question about crypto disclosure on IRS Form 1040, Individual Income Tax Return. In addition to disclosing the highest total balance, the crypto owner must also disclose the crypto custodian, location, and crypto account number (or other identifier). Assuming the reporting rules remain the same, the crypto accounts would be reported on FinCEN Form 114 and filed electronically by April 15 of the next applicable year (such as tax returns).
Crypto FBAR Requirements
But not all crypto accounts would be reportable. The FBAR filing requirement only applies to foreign accounts whose balance exceeds $ 10,000 (in total) for the tax year. So if two accounts have a combined account balance of more than $ 10,000 at the same time, both accounts are reportable.
For example, if one owns $ 4,000 in Cardano (ADA) and another $ 7,000 in Bitcoin (BTC) on a non-U.S. Exchange, both holdings are reportable as they total more than $ 10,000. Therefore, crypto owners must carefully monitor the fair market values of their crypto accounts throughout the year in a volatile market. What’s worth $ 5,000 today could cross the $ 10,000 threshold in a short time.
Sanctions and Non-Disclosure
And not disclosing a reportable account is a silly message. FBAR sanctions are draconian. For “unintentional” FBAR submission errors, the fine is $ 10,000 per error. The courts are currently moving as to whether that is $ 10,000 per account per year or just per FBAR owed.
The IRS takes – predictably – the first position. If the fine is $ 10,000 per account per year, it’s easy to see how FBAR fines can easily exceed the actual balances of the accounts themselves. That is, a taxpayer could pay more in FBAR fines than the value of their bills. And for “willful” non-compliance, the penalties waver on unscrupulousness. They prescribe a civil fine for deliberately not filing an FBAR of up to $ 100,000 or 50% of the balance in the account at the time of the violation. Willful violations include both willful and reckless non-disclosures.
There is another requirement that comes from the possible changes to the FBAR regulation. At the bottom of Schedule B of Form 1040 is a series of questions about foreign bank accounts. If crypto accounts fall within the new FBAR regulations, then an FBAR reporting taxpayer would presumably also have to answer the Schedule B questions in the affirmative. And answering in the negative is not a good choice. Answering “no” unfairly to questions from the Schedule B foreign bank account is considered “willful” behavior in the eyes of the IRS.
And most importantly, unlike the FBAR rules, there is no account value threshold on the Schedule B questions. Voluntary disclosure of foreign bank accounts does not begin or end with the filing of an annual FBAR. Where applicable, the taxpayer must also truthfully answer the questions on the Annex B foreign bank account.
Unfortunately, the work doesn’t stop there. If crypto accounts are considered Reportable Accounts under FBAR regulations, then, of course, they are Reportable Accounts under IRS Form 8938. If U.S. taxpayers have a financial interest in certain foreign financial assets and meet certain account balance thresholds, they must also file a Form 8938 with their Form 1040 individual income tax return. Form 8938 is an appendix to Form 1040. The same foreign bank accounts that must be reported under FBAR regulations are currently the same types of accounts that must be reported on Form 8938. In fact, the FBAR disclosures spill over to Form 8938.
However, the reporting thresholds are different. To be reportable, to unmarried taxpayers, the foreign bank account balance must be greater than $ 50,000 on the last day of the tax year, or if more than $ 75,000 at any time during the year, to imply Form 8938. The barriers are higher for Married Filing Jointly taxpayers. And similar to FBAR, the penalties are harsh. There is a $ 10,000 fine for non-disclosure on Form 8938 and an additional $ 10,000 for each 30 days of non-filing after the IRS notifies the taxpayer of a non-disclosure for a possible maximum fine of $ 60,000 .
Criminal sanctions may also apply. In fact, FBAR and Form 8938 are two peas in a pod, and a crypto owner may need to report on both forms. See here for a good comparison of FBAR and Form 8938.
Tax amnesty for crypto
There may be a glimmer of good news in all of this. I have previously advocated for a crypto income tax amnesty program, and this could be a case where amnesty comes up. Currently, there are several voluntary disclosure procedures for not filing FBARs. If crypto accounts are the type of accounts now required to be reported under FBAR regulations, the same amnesty procedures should likely apply to crypto accounts as well. Unless the new regulations are an exception, crypto accounts may fall under the types of accounts available to participate in the Offshore Voluntary Disclosure procedures. More importantly, the procedures include “both” sanctions for secrecy and sanctions for non-reporting of income. It is an amnesty program that includes both.
For example, let’s assume the new FBAR regulations come into effect in 2021. A crypto owner named Joe fails to report capital gains on his crypto in the tax years 2021, 2022 and 2023. In every year Joe also fails to file FBARs on his crypto accounts. Then, in 2024, Joe wants to clean up. Presumably Joe could then participate in the FBAR’s voluntary disclosure procedures and document both his failure to file his FBARs and his failure to report his crypto capital gains. While Joe has to pay a miscellaneous 5% fine under voluntary disclosure procedures, he can avoid the $ 10,000 “unintentional” fine for each year and avoid any additional fines associated with failing to report crypto earnings, including the 20% accuracy-related sanctions and penalties for civil fraud. This could be a back door to crypto income tax amnesty.
Notice 2020-2, which started out as a harmless one-paragraph communication, has broad implications. It’s not uncommon for a tax filing obligation to touch one or more tax forms, as is the case here. Crypto owners do well to understand the breadth of the tax code. A misstep in one area is likely a misstep in another.
This article is for general information purposes and is not intended and should not be construed as legal advice.
The views, thoughts and opinions expressed here are solely of the author and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Jason Morton is an attorney in North Carolina and Virginia and is a partner at Webb & Morton PLLC. He is also a Judge Attorney in the Army National Guard. Jason focuses on tax defense and tax litigation (foreign and domestic), estate planning, corporate law, asset protection and cryptocurrency taxation. He studied blockchain at the University of California, Berkeley and studied law at the University of Dayton and George Washington University.