Overview of Federal Regulation
As transactions involving cryptocurrencies, such as Bitcoin, become more prevalent, regulatory oversight has been evolving.
Cryptocurrency transactions are processed online through “blockchains” that facilitate confidential electronic transfers directly from one party to another without going through a financial institution. These transactions, however, are not free from regulatory scrutiny. Currently, the federal government, through the U.S. Department of Treasury Financial Crimes Enforcement Network (FinCEN) and the Internal Revenue Service (IRS), regulate these transactions. For example, the Bank Secrecy Act regulations on money services businesses can apply to blockchains processing cryptocurrency transactions regardless of whether the cryptocurrency is physical or digital, whether the type of electronic ledger used to record the transactions is centralized or distributed, and regardless of the type of technology used to transmit the value.
Government oversight of cryptocurrency transactions is one exception to the privacy of information on a blockchain. For example, the anti-money-laundering requirements of the Bank Secrecy Act of 1970 require reports to the government of suspicious activities. Under those requirements, a “money services business” must have a formal, written program in place to assess the risk and prevent the completion of money-laundering transactions and transactions that finance terrorist activities. Money transmitters can comply with these requirements by incorporating procedures into their anti-money-laundering programs that allow them to track and monitor the transaction history of cryptocurrency through publicly visible ledgers. To assess risks, a money services business is additionally required to determine both the identity and profile of its customers and know enough about them to determine the risk level they represent.
Taxation of Cryptocurrency Transactions
In addition to being subject to banking laws, cryptocurrency transactions are taxable. The sale or exchange of cryptocurrency, or its use to pay for goods or services is treated as a sale or exchange of property for federal tax purposes. This means that each time cryptocurrency is used to pay for goods or services, it creates a reportable tax event.
The IRS issued individuals letters seeking capital gains tax, penalties and interest on these transactions. Tax rates on capital gains can be at 15% or 20%. In addition there is a 3.8% net investment surtax on modified adjusted gross income (MAGI) over $250,000 for joint return filers ($200,000 for single filers). The statute of limitations on collecting taxes is generally three years after a return’s due date, but that limit expands to six years if income is understated by more than 25%.
IRS has issued very little guidance on the mechanics of taxing cryptocurrency or valuing it for purposes of determining a tax liability. Nevertheless, IRS officials have indicated that criminal tax indictments involving cryptocurrencies are expected soon. Such indictments would be based in tax fraud and involve facts showing the intentional evasion of tax.
For those in receipt of IRS letters asserting tax on cryptocurrency transactions, the general advice is to get help in addressing the inquiry and paying any taxes due.
Cryptocurrency transactions may be a convenient way of paying for goods and services in some situations, and may create a valuable stream of income for entities facilitating such exchanges. Entities handling cryptocurrency exchanges, however, must be aware of and comply with applicable federal banking and tax oversight. Likewise, persons involved in cryptocurrency transactions should understand that those transactions are not free from federal scrutiny, even if the transactions are processed over blockchains that ordinarily encrypt information traceable to a user. Finally, persons making transactions with cryptocurrency are subject to taxation under the rules that treat the transfer of cryptocurrency as the sale of capital assets.
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