The United States Department of Treasury is again sharpening its sword upon crypto. In January 2021, the Department of Treasury’s Financial Crimes Enforcement Network issued Notice 2020-2. The Notice states that FinCEN intends to amend its regulations concerning the reporting of foreign financial accounts to include digital currency as a type of reportable account.
In simple terms, this means FinCEN may soon require crypto users to file annual Reports of Foreign Bank and Financial Accounts, or FBARs, for crypto held on foreign exchanges. The effects of such an amendment are expansive. A mere paragraph long, the notice carries several implications that affect crypto owners — well beyond a simple FBAR report.
Presently, cryptocurrency accounts are not reportable accounts within the meaning of the FBAR regulations. Should a change occur, crypto owners — already burdened by heightened Internal Revenue Service focus — would then be required to report annually the highest aggregate balances of their crypto accounts to FinCEN.
This requirement is in addition to the crypto disclosure question on IRS Form 1040, Individual Income Tax Return. Along with disclosing the highest aggregate balance, the crypto owner must also disclose the custodian of the crypto, its location and the crypto account number (or some other identifier). Assuming the reporting rules stay the same, the crypto accounts would be reported on FinCEN Form 114 and filed electronically by April 15 of the following applicable year (like tax returns).
Crypto FBAR requirements
But not all crypto accounts would be reportable. The FBAR filing requirement only applies to foreign accounts whose balances exceed $10,000 (in the aggregate) for the tax year. So, if two accounts have a combined account balance greater than $10,000 at any one time, then both accounts are reportable.
For example, if one holds $4,000 of Cardano (ADA) and another has $7,000 of Bitcoin (BTC) on a non-U.S. exchange, both holdings are reportable because, in the aggregate, they exceed $10,000. Therefore, crypto owners should carefully track the fair market values of their crypto accounts throughout the year in a volatile market. What is worth $5,000 today could exceed the $10,000 threshold in a short time.
Penalties and failures to disclose
And failure to disclose a reportable account is a fool’s errand. FBAR penalties are draconian. For “non-willful” failures to file FBARs, the penalty is $10,000 per failure. The courts are currently in flux over whether that $10,000 is per account per year or just per FBAR due.
The IRS — predictably — takes the former view. If the $10,000 penalty is per account per year, it is easy to see how FBAR penalties can easily exceed the actual balances of the accounts themselves. That is, a taxpayer could pay more in FBAR penalties than the worth of their accounts. And for “willful” non-compliance, the penalties teeter on unconscionability. They prescribe a civil penalty for willfully failing to file 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 knowing and reckless nondisclosures.
There is yet another requirement birthed from the possible changes in the FBAR regulation. At the bottom of Schedule B of Form 1040, there is a series of foreign bank account questions. Presumably, if crypto accounts fall within the new FBAR regulations, then an FBAR-reporting taxpayer would also need to answer the Schedule B questions in the affirmative. And answering in the negative is not a good choice. Untruthfully answering “no” to the Schedule B foreign bank account questions is considered “willful” behavior in the eyes of the IRS.
And importantly, unlike the FBAR rules, there is no account value threshold with the Schedule B questions. Voluntary foreign bank account disclosures do not begin and end with the filing of an annual FBAR. If applicable, the taxpayer must also answer the Schedule B foreign bank account questions truthfully.
Regrettably, the work does not stop there. If crypto accounts are deemed reportable accounts under the FBAR regulations, then they are naturally reportable accounts under IRS Form 8938. If U.S. taxpayers have a financial interest in specified 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 attachment to Form 1040. The same foreign bank accounts reportable under the FBAR regulations are currently the same types of accounts reportable on Form 8938. In effect, the FBAR disclosures bleed over to Form 8938.
The reporting thresholds are different, however. To be reportable, for unmarried taxpayers, the foreign bank account balances must exceed $50,000 on the last day of the tax year, or if more than $75,000 at any time during the year, to implicate Form 8938. The thresholds are higher for Married Filing Jointly taxpayers. And akin to FBAR, the penalties are heavy-handed. There is a $10,000 penalty for failure to disclose on Form 8938 and an additional $10,000 for every 30 days of non-filing after the IRS notices the taxpayer of a failure to disclose for a potential maximum penalty of $60,000.
Criminal penalties may also apply. Effectively, FBAR and Form 8938 are two peas in a pod, and a crypto owner may need to report on both Forms. For a good comparison of FBAR and Form 8938, see here.
Tax amnesty for crypto
In all of this, there may be a ray of good news. I previously argued for a crypto income tax amnesty program, and this may be a case where amnesty emerges. Currently, there are several voluntary disclosure procedures for failures to file FBARs. Presumably, if crypto accounts are the types of accounts now reportable under the FBAR regulations, then the same amnesty procedures should apply to crypto accounts as well. Unless the new regulations carve out an exception, crypto accounts may fall within those types of accounts available to participate in the Offshore Voluntary Disclosure procedures. And importantly, the procedures capture “both” penalties for nondisclosure and the penalties for the non-reporting of income. It is an amnesty program that covers both.
For example, let’s assume the new FBAR regulations go into effect in 2021. A crypto owner named Joe fails to report capital gains on his crypto in tax years 2021, 2022 and 2023. In each year, Joe also fails to file FBARs on his crypto accounts. Then, in 2024, Joe wants to come clean. Presumably, Joe can then participate in the FBAR voluntary disclosure procedures and capture both his failure to file his FBARs as well as his failure to report his crypto capital gains. While Joe must pay a 5% miscellaneous penalty under voluntary disclosure procedures, he can avoid the $10,000 “non-willful” penalty for each year and avoid any additional penalties associated with his non-reporting of crypto income, including the 20% accuracy-related penalty and civil fraud penalties. This may be a backdoor into crypto income tax amnesty.
What started as an innocuous one-paragraph notice, Notice 2020-2 carries broad implications. It is not uncommon for a tax reporting requirement to touch one or more tax forms as it does here. Crypto owners are well served 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 to be and should not be taken as legal advice.
The views, thoughts and opinions expressed here are the author’s alone and do not necessarily reflect or represent the views and opinions of Cointelegraph.
Jason Morton practices law in North Carolina and Virginia and is a partner at Webb & Morton PLLC. He is also a judge advocate in the Army National Guard. Jason focuses on tax defense and tax litigation (foreign and domestic), estate planning, business law, asset protection and the taxation of cryptocurrency. He studied blockchain at the University of California, Berkeley and studied law at the University of Dayton and George Washington University.