Implications of Holding Cryptocurrency in Foreign Wallets

Online marketplaces present cryptocurrency as a medium of exchange free of interference by powers like national governments and banks. Like many other nations, however, the United States is strengthening its stance that cryptocurrency is subject to laws and regulations like every other form of property. One of the most effective resources for the US government to assert oversight over cryptocurrency is the IRS.

While Bitcoin was launched in 2009 as the first decentralized cryptocurrency, the IRS uses much older laws to require reporting of digital currencies. The Bank Secrecy Act of 1970 requires businesses to keep records and file reports that are determined to have a high degree of usefulness in criminal, tax, and regulatory matters. A major part of this act is the requirement to report foreign bank and financial accounts. US taxpayers are required to file a FinCEN Form 114 to report:

  1. a financial interest in or signature or other authority over at least one financial account located outside the United States if
  2. the aggregate value of those foreign financial accounts exceeded $10,000 at any time during the calendar year reported.

But if cryptocurrency exchanges promise to avoid governmental regulations, do cryptocurrency wallets based in other countries meet the definition of a foreign account?

As far as the IRS is concerned, the answer is a resounding, “YES.”

The seriousness of these requirements is backed up by a range of civil and criminal penalties. At the upper end, a willful violation can incur a $250,000 penalty and 5 years in prison (IRS Pub. 5569).

More commonly, taxpayers may simply not realize that their holdings require additional filings. One common misconception is that if cryptocurrency is merely held but isn’t traded for a gain or loss and doesn’t produce interest income, then it is not reportable. In fact, the value of the account itself determines whether the taxpayer must file a FinCen Form 114. The $10,000 threshold becomes even more significant as more taxpayers consider cryptocurrency as a possible vehicle for retirement savings. Furthermore, investors with higher levels of holdings have additional reporting requirements. Taxpayers must file Form 8938 annually with their personal income tax return if the total value of their foreign assets exceeds $50,000 on the last day of the tax year or $75,000 at any time during the tax year.

The account holder is required to disclose:

  • Name on the account,
  • Account number,
  • Name and address of the foreign bank,
  • Type of account, and
  • Maximum value during the year.

The most important step you can take as a taxpayer to protect yourself against potential pitfalls like failure to report foreign accounts is to build a relationship with an accounting firm that you trust. Communication about your financial strategies during the year not only prevents surprises at tax time but can help you avoid landmines in the ever-changing landscape of digital investments.

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