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Bitcoin Tax Reporting Requirements

Bitcoin has been in the news frequently lately, particularly since the collapse of the Japanese-based Bitcoin exchange, Mt. Gox. Bitcoin is a digital currency and peer-to-peer payment system created in 2009. Since 2009, the use of bitcoins has expanded significantly. Bitcoins can be bought and sold for various currencies, generally through a series of online exchanges where participants can bid on bitcoins from individuals or buy them at market price from companies.

The unique characteristics of Bitcoin as a digital currency leaves many questions about tax reporting requirements, such as whether users of Bitcoin must file FinCEN Form 114, Report of Foreign Bank and Financial Accounts (FBAR).U.S. taxpayers who have an interest in, or signatory or other authority over a foreign financial account, such as a bank account, securities or other similar foreign accounts must file an FBAR if the aggregate value of the foreign accounts exceeds $10,000 at any time during the calendar year. As of October 1, 2013 the FBAR form must be filed through the Financial Crimes Enforcement Network’s (FinCEN’s) Bank Secrecy Act E-Filing System on or before June 30thof the year following the calendar year being reported. For example, toreport foreign accountsheld open in 2013, the taxpayer must file the FBAR by June 30, 2014.

The first major issue with whether a U.S. taxpayer must file an FBAR on a Bitcoin account is whetherthese accounts qualify as a “financial account” as defined on the FBAR form.  The FBAR instructions define a “financial account” to include “a securities, brokerage, savings, demand, checking, deposit, time deposit, or other account maintained with a financial institution (or other person performing the services of a financial institution).”

FinCEN could deem a Bitcoin account a financial account, particularly since FinCEN has required some exchanges to register as Money Service Businesses.  SeeFIN-2013-G001, “Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies,” March 18, 2013.  Furthermore, bitcoins can be spent like regular currency to purchase items or can be exchanged for various currencies that would be subject to the FBAR requirements if held in a financial account.

On the contrary, significant parallels can be drawn between bitcoins and a safety deposit box holding gold coins.  A user that owns bitcoins can essentially print out the bitcoins on paper and hold them physically, such as holding gold coins in a safety deposit box.  The IRS has stated that a U.S. taxpayer who owns gold coins in a safety deposit box has “direct ownership” of this asset, which means the taxpayer does not need to file an FBAR or a Form 8938, Statement of Specific Foreign Financial Assets (discussed below).  However, if the gold coins are held in an account at a foreign bank, the value of those gold coins, and possibly bitcoins, must be reported on the FBAR and Form 8938.

As discussed above, the U.S. taxpayer who owns bitcoinsmay also be required to file Form 8938, Statement of Specific Foreign Financial Assets with his or her annual tax return, if the Bitcoin accounts are financial accounts.  Whether a taxpayer is required to file this form depends on where the taxpayer lives, the taxpayer’s filing status, and the value in the accounts.  For example, unmarried taxpayers living in the United States must file Form 8938 if the total value of your specified foreign financial assets is more than $50,000 on the last day of the tax year or more than $75,000 at any time during the tax year.

Failure to comply with the above reporting requirements can result in steep penalties to the unwitting taxpayer.  Failure to file an FBAR may result in civil penalties for negligence, pattern of negligence, non-willful, and willful violations.  These penalties range from a high penalty for willful violations, equal to the greater of $100,000 or 50% of the balance in the account at the time of violation, to a low penalty of $500 for negligent violations.  For failing to file a correct Form 8938, the taxpayer could face a failure-to-file penalty of $10,000, criminal penalties, and if the failure to file results in underpayment of tax, an accuracy-related penalty equal to 40% of the underpayment of tax and a fraud penalty equal to 75% of the underpayment of tax.

U.S. taxpayers who have bitcoins would benefit from the experienced tax attorneys of the Law Office Of Jeffrey B. Kahn, P.C. representing you to avoid the pitfalls associated with failure to comply with the reporting requirements associated with owing bitcoins.

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