Virtual Currency, FBAR, and the Ripple Effect

We welcome back guest blogger James Creech. In this post James explains some of the current uncertainties surrounding virtual currency, particularly in how future IRS guidance might interact with legal positions taken by other federal agencies. Christine

Recently FinCen informed the AICPA Virtual Currency Task Force that Bitcoin and other Virtual Currencies do not trigger FBAR reporting even when held in an offshore wallet.

This guidance comes as a bit of a surprise for some tax practitioners. Conventional wisdom had been that there was a difference between Virtual Currencies being held in cold storage on a thumb drive in a foreign county, and those being held by a foreign third party who also retained the private keys to the Virtual Currency as a part of their service. It was believed that if the private keys were stored by the wallet service, and the wallet service could convert the Virtual Currency to fiat currency, then the account could be considered similar to an online poker account and reportable under U.S. v Hom, No. 14-16214, 9th Cir., (7/26/16).

While this will be welcome news for many taxpayers who hold foreign wallets, this guidance by FinCen has the potential to be more impactful on the tax consequences of Virtual Currencies than would initially be apparent. The IRS has long relied on other agencies to define key terms, and to more fully develop the legal nature of Virtual Currencies. This FinCen guidance may be the beginning of a deepening rift between agencies.


It is expected that the IRS will be releasing new Virtual Currency guidance shortly that will address some of the technological developments in the industry. One of the areas that could be addressed by this guidance is whether Virtual Currency held in foreign wallets is reportable on Form 8938. If the IRS decides that the Hom rational is correct and that foreign wallets are reportable this will create another significant distinction between the FBAR and Form 8938. For taxpayers this creates a higher likelihood of unfilled Form 8938’s due to taxpayer error and greater confusion between FBAR and Form 8938 requirements. I expect that this increased error rate will be higher than normal due to the fact that the Virtual Currency community relies heavily on industry blogs that many times are more interested in promoting virtual currency purchases rather than informing readers about compliance requirements.

For tax practitioners this split also raises questions of how much weight to put on the guidance of other administrative agencies. Because the IRS has issued so little guidance on Virtual Currency there are very few absolutes. We know that Virtual Currency is property because Notice 2014-21 clearly says so. What we don’t know is how far that definition goes, or if it can be treated like other specialized types of property. In the non-IRS context, the SEC has defined certain types of Virtual Currency as securities, and the CFTC has said that it is a commodity. It logically follows that if the IRS says a certain Virtual Currency is property, and the SEC says this Virtual Currency is a security, that a dealer in that particular Virtual Currency should be able to use a mark to market election under IRC 475. Given that Virtual Currencies as a whole suffered a bear market in 2018, a mark to market treatment might provide a desirable tax loss for many in the industry.

If there is a split in the FBAR and Form 8938 definitions, then assumptions that the IRS will allow taxpayers to import definitions from other agencies in order to tackle unaddressed issues lose some of their logic. It is impossible to overstate how important prior FinCen definitions are for IRS Virtual Currency guidance. The root definition of what is a Virtual Currency for IRS purposes is based in a 2013 FinCen definition of “convertible virtual currencies”. If the IRS does not see eye to eye with FinCen then there is a diminished likelihood that the IRS would adopt a CFTC definition and allow Virtual Currencies the same type of preferential tax treatments that they would allow for an established commodity. Of course the opposite reaction might also be true. If the IRS is the first agency to state that foreign wallets are reportable, we might see FinCen respond by adjusting their guidance to require FBAR disclosure as well. Either way, the pending IRS guidance will tell us a lot about how the IRS is thinking about Virtual Currencies and how it intends to incorporate guidance from other administrative agencies.

IRS Seeks Information via John Doe Summons Request on Bitcoin Users

Last week in federal district court in Northern California the Department of Justice filed a petition seeking authority to obtain records the records of all customers who bought virtual currency from Coinbase, a virtual currency exchange company, from 2013 to 2015. The John Doe summons request came on the heels of a TIGTA report on the challenges associated with the growing use of virtual currency, which I discussed here in TIGTA Issues Warning on Compliance Issues Associated With Use of Virtual Currencies.

We have not previously discussed John Doe summons requests. Essentially, a John Doe summons is a summons that does not identify the person with respect to whose liability the summons is issued. The government has used it extensively in its efforts to uncover the identities of taxpayers hiding assets in previously undeclared offshore accounts. (We discuss the use of John Doe summonses in Saltzman and Book IRS Practice and Procedure Chapter 13.05[2], and readers who want more should review the chapter’s discussion).


Sections 7609(c)(3) and (f) authorize the Service to issue a John Doe summons pursuant to an investigation of a specific, unidentified person or ascertainable group or class of persons. The summons requires district court approval in an ex parte proceeding. Before granting the summons, in addition to the investigation requirement the DOJ on behalf of the Service must also show a reasonable basis to believe that that person or group or class of persons may fail or may have failed to comply with any provision of the internal revenue laws; and that the identity of the persons and the information sought in the summons is not readily obtainable from other sources.

When the IRS seeks the use of a John Doe summons, the IRM provides that the Service should be far along in its development of the issues relating to the request:

The Service should no longer be in the information-gathering or research stage of a project when it decides to seek court authorization to serve a John Doe summons. The project research should be sufficiently developed to enable the Service to identify a specific tax compliance problem. The Service should be prepared to investigate the tax liabilities of specific taxpayers based on the information received from the John Doe summons.

IRM Necessary Purpose (Nov. 22, 2011).

To support the issuance of the John Doe summons request, the DOJ typically provides the district court declarations from IRS revenue agents who are in a position to provide information as to how the particular facts justify the issuance of the summons.

We have uploaded the declaration of the IRS Revenue Agent David Utzke that was filed in support of the John Doe summons request to seek the customer records. It makes for fascinating reading, detailing what IRS has learned to date on ways that US taxpayers are using the currency to (attempt to) disappear from the taxman and how the IRS in its constant game of a whack a mole is trying to figure out the ways that this technology will complicate IRS efforts to combat offshore evasion.

As the TIGTA report discussed, virtual currency usage complicates tax administration. Its use is growing (see paragraph 28 of the declaration where Revenue Agent Utzke estimates that the transaction value in dollars of bitcoin usage in 2015 exceeded $10 billion). I write this as I have just returned from a conference on how advances in technology and social knowledge can improve tax administration. Utzke’s declaration reveals what he has learned from investigating taxpayers who have used bitcoin as a way to hide income, including how some taxpayers shifted to bitcoin when IRS offshore efforts heated up a few years ago (see paragraph 32 for example). This first major public IRS effort to address the challenges of virtual currency reveals that with technological changes and advances come new ways that black-hatted taxpayers can game the system.

Update: For more on the John Doe summons request on Coinbase, see our Forbes blogging colleague Kelly Phillips Erb in IRS Wants Court Authority to Identify Bitcoin Users & Transactions

Jack Townsend at Federal Tax Crimes has an excellent and more detailed discussion of the summons request, including Coinbase’s likely opposition to the request, Jack’s initial take on the uphill battle the company faces, and the SOL impact of the John Doe summons request.

TIGTA Issues Warning on Compliance Issues Associated With Use of Virtual Currencies

Today is an historic day where the country and the world are absorbing what portends to be a sea change in America’s place in the world. It is hard to see what the direct impact a Trump presidency is going to have on tax administration. With control of the White House and both branches of the legislature I suspect that there will be an appetite and capacity for significant tax legislation.

At the same time, even apart from the political changes of the day, technological advancements suggest that tax administration is in the midst of a disruptive period. We have discussed some of those issues in looking at IRS Future State plans, as well as changes in Appeals as it shifts from person to person conferences and looks to virtual conferences as a way to connect with taxpayers and practitioners. One of the technological changes we have not discussed is the invention of bitcoin and the growth of virtual currencies. Those virtual currency developments highlight special challenges for tax administrators around the world, both with respect to traditional tax compliance issues and issues relating to bank secrecy that some tax agencies such as the IRS administer.


We have largely ignored the growth of virtual currencies, and while IRS issued a notice about them in 2014 (Notice 2014-21) it seems that IRS and Congress have likewise not focused sufficient energy on some of the issues associated with the use of bitcoin. At least that is the message in TIGTA’s As the Use of Virtual Currencies in Taxable Transactions Becomes More Common, Additional Actions Are Needed to Ensure Taxpayer Compliance.   In the report TIGTA warns that the spread of virtual currencies creates special challenges for tax administrators who rely heavily on the combination of self-reporting and third-party reporting to backstop income tax compliance. It also notes that IRS received significant comments in response to the issuance of its 2014 notice yet has failed to publicly address those comments or spend significant resources on educating the public on the difficult tax compliance issues that flow from the mining and use of virtual currency. IRS generally agreed with TIGTA’s recommendations but noted that it faces challenges in allocating scarce resources among competing priorities so there does not seem to be much agency urgency on these issues.

This is a brief post on a topic that deserves more attention. For those looking to wrap around the history and mechanics of bitcoin, I recommend a 2011 New Yorker article by Joshua Davis called The Crypto-Currency. A 2016 New Yorker article by Adrian Chen discussing the importance of the search for the mythic Saroshi Nakomoto, the creator of Bitcoin, connects the development and growth in virtual currency to a deep distrust of international and national monetary powers, a theme close to the surface in President-elect Trump’s messages. A Forbes piece by contributor Karl Whelan called How is Bitcoin Different From the Dollar also nicely summarizes and links some academic papers on the topic.

IRS in its 2014 notice provides that virtual currency is treated as property for U.S. federal tax purposes. Once you start from that premise, as IRS explains in a summary of its notice, “[g]eneral tax principles that apply to property transactions apply to transactions using virtual currency.” In other words, when you use property (like virtual currency) rather than old-fashioned US dollars to pay for goods and services you have a separate tax consequence that stems from in effect the tax system treating the use of virtual currency as a deemed sale for its fair market value upon a taxpayer using it to purchase goods or services.

As the IRS in its 2014 summary notes, that has major implications:

  1. Wages paid to employees using virtual currency are taxable to the employee, must be reported by an employer on a Form W-2, and are subject to federal income tax withholding and payroll taxes.
  2. Payments using virtual currency made to independent contractors and other service providers are taxable and self-employment tax rules generally apply.  Normally, payers must issue Form 1099.
  3. The character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer.
  4. A payment made using virtual currency is subject to information reporting to the same extent as any other payment made in property.

The TIGTA report flags some of the complications that spin off that IRS starting point:

Notice 2014-21 requires a taxpayer who receives virtual currency as payment for goods or services to compute gross income using the fair market value of the virtual currency, measured in U.S. dollars, as of the date that the virtual currency is received. However, because bitcoins are divisible to eight decimal places, this means that each bitcoin can be divided up into 100 million pieces. Based on this general guidance, when a portion of a bitcoin is used to make a purchase, taxpayers will have to treat the transaction as property and determine their tax basis for the bitcoin on the day of the purchase. For example, if a taxpayer uses a portion of a bitcoin to buy a cup of coffee each day for one week, he or she will have to determine what portion of the bitcoin was used to make the purchase based on the daily exchange rate, convert it into U.S. dollars, and keep a record of each transaction so that the gain or loss from his or her virtual currency property can be properly reported. Notice 2014-21 does not provide taxpayers with guidance on what records should be kept and how the records should be maintained. Due to the potential complexity of reporting otherwise simple retail purchase transactions related to virtual currencies, further guidance is needed to help taxpayers voluntarily comply with their tax obligations.

While tax compliance does require some effort, to put consumers through the hoops needed to determine consequences on each use of bitcoin is unreasonable. TIGTA compared the Australian treatment with IRS’s treatment. It seems that the Australian Taxation Office also determined that bitcoin use could trigger a taxable event but the ATO “decided that there will be no income tax implications if the person is not in business or carrying on an enterprise and is simply paying for goods or services. Any capital gain or loss realized from the disposal of the virtual currency is to be disregarded provided its cost is $10,000 (Australian dollars) or less.” The de minimis carve out goes a long way in removing complications that spin from using virtual currency from day to day consumption transactions and pegs compliance costs for larger purchases.

TIGTA also notes that while reporting applies to payments made in virtual currency IRS information returns (e.g., 1099 W-2 etc) “do not provide the IRS with any means to identify that the taxable transaction amounts being reported were specifically related to virtual currencies.” Without that ability the reporting of those virtual payments (if in fact payors comply) does not contribute to IRS use of that information to test compliance on the user-level. TIGTA sensibly recommends that IRS “revise third-party information reporting documents to identify the amounts of virtual currency used in taxable transactions.” IRS agreed with that recommendation though it stated that due to competing funding priorities it did not view that as a priority.


The world changes at an increasingly fast pace. The buzzword in industry and academics is disruption. Disruptive changes can have disastrous effects on those who fail to adapt. Tax agencies are not immune to those forces. The growth in the use of virtual currencies over the past five years combined with the growing distrust in institutions as reflected in some of the recent political events in Europe and here suggest that there may be major changes in the way that people interact with each other in the commercial sphere. Consumers who use traditional greenbacks place faith in the United States. Consumers who use virtual currencies place faith in technology and code, which ensures that people are spending a bitcoin or fraction thereof only once.

Bitcoin was born when its creator was disgusted with the financial meltdown in 2008, with its creator thinking that people should and could not trust governments to behave responsibly. If governments move down the path of irresponsibility we may be entering a new phase in the use of virtual currency. In fact today bitcoin values have soared in light of the election (see e.g., The Telegraph’s Bitcoin price jumps as investors flock to safety after Donald Trump election victory . A tax agency that ignores those possible changes does so at its peril.