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.

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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.

Tax Court Urged to Permit Limited Scope Appearances by Counsel

We welcome first-time guest blogger James Creech to Procedurally Taxing. James is a tax controversy attorney in solo practice in San Francisco and Chicago. He currently chairs the Individual and Family Tax Committee of the ABA Section of Taxation. Here James discusses comments submitted by the ABA Tax Section urging the adoption of a limited appearance rule in Tax Court, and he explains his support for the proposal from the perspective of a pro bono calendar call attorney. As one of the authors of the comments I hope the Court agrees with James. Christine

On October 3rd, the ABA Section of Taxation submitted comments to the Tax Court urging the court to amend Tax Court Rule 24 in order to create a new limited scope appearance. The comments are primarily aimed at allowing pro-bono volunteers to speak on the record during a calendar call without having to worry about broader ethical issues and without worrying about assuming responsibility beyond a solitary appearance. Importantly, while calendar calls are the primary focus, the Tax Section recommendation does not restrict the use of limited scope appearances to only calendar calls. The comments urge permission for limited scope representation in any situation where 1. the limitation is reasonable given the circumstances; 2. the limitation does not preclude competent representation or violate other rules; and 3. the client gives informed consent. This broader request would allow pro-bono volunteers to not only assist during the trial setting session but would open the door to assisting during trial itself, or during appeals hearings in docketed tax court matters.

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A limited scope representation rule could help a large number of taxpayers. According to the comment 69% of all petitioners are unrepresented. When looking only at S cases that number jumps to 91%. Currently during the typical calendar call session there is a limited amount of time where petitioners can meet with a pro-bono attorney and often they are overwhelmed with the process. Allowing limited scope representations would allow pro-bono volunteers to increase their assistance and reduce the burden on both petitioners and the Court.

Under the Tax Section’s proposal, beginning a limited scope representation would require the pro-bono volunteer to complete a Tax Court form that clearly identified the date, the time period of the representation, the activity, and the subject matter. On the sample forms attached to the comments, these lines are prominently displayed and are likely to reduce much of the client’s uncertainty the limited representation. This form would then be signed by the pro-bono attorney and served on both the Court and opposing counsel. For representations that are part of the calendar call program, the ABA Tax Section comment language specifically states that the representation ends at the conclusion of the calendar call. If a practitioner wishes to extend the representation through trial a separate notice of completion must be filed with the Court and served upon respondent.

As a frequent calendar call volunteer, the recommendations made in the ABA Tax Section comment are welcome and frankly overdue. One of the biggest frustrations of a calendar call pro-bono attorney is the inability to speak to the court on behalf of a pro-se litigant even when it comes to something as simple as requesting a continuance. Calendar Call volunteers often spend a significant amount of time with a pro-se litigant teaching them the basics of Tax Court procedure, what facts are relevant, and what the roles of Chief Counsel attorneys and the Court are. At the conclusion of the meeting it is not unusual to wait in the back of the courtroom only to watch them step up to the podium and start rehashing irrelevant facts that are unhelpful to the Court. It then takes time for the Judge to give the opportunity for the litigant to speak, inform them why they are in court today, and to ask questions about what their goals are. Often what should be a two minute request for a specific trial day or a continuance can turn in to ten minutes of the Judge trying to get a sense of the evidentiary issues and if trial is the fairest way to resolve the case. Allowing a pro-bono attorney to approach the podium with the petitioner would eliminate these issues. I believe a limited scope rule would give petitioners a better sense that they were able to communicate their needs and that they had a fair opportunity to be heard both of which are essential to due process.

Enacting the ABA Tax Section’s proposal for limited scope representation would benefit volunteers, pro-se taxpayers, chief counsel, as well as the Court. Volunteers would more certainty that their time would be put to good use. Pro se litigants would get a fairer outcome because they would be able to better communicate their needs to the Court and explain the relevant facts in their case. Finally, the Court would benefit from increased efficiency and a trial record that better reflected what the parties believed the facts to be.

Overall the Tax Section comment does a great job of striking a balance between the needs of volunteer attorneys ethical compliance and workload considerations with their desire to help pro-se petitioners. The inclusion of clear sample forms gives the Court and pro-bono volunteers a better idea of how this rule could be implemented and what pro-se litigants might expect should this proposal be adopted. In my opinion the Tax Court should implement a limited scope rule that is substantially similar to what the ABA Tax Section proposes.