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Articles/Facebook-Unveils-Crypto-Wallet-Based-On- Currency-Libra-11560850141 International Journal TM Reproduced with permission from Tax Management In- ternational Journal, Vol. 48 No. 9, 09/13/2019. Copyright ஽ 2019 by The Bureau of National Affairs, Inc. (800-372- 1033) http://www.bna.com cryptocurrencies and the need for government regula- Taxation of tory oversight. More specifically, the group restated Cryptocurrencies: In its previous position for Financial Action Task Force (FATF) to clarify the standards applicable to crypto- Anticipation of the IRS’s assets. France, New Zealand, the U.K., Israel, and a host of other countries are bolstering their understand- Call ing of virtual currencies as well as their legal and tax * consequences, respectively. The Organization for Eco- by Sahel Ahyaie Assar nomic Cooperation and Development (OECD), for example, has initiated a working group to assess cryp- tocurrencies and its impact on corruption and fraudu- lent activities.1 Similarly, businesses are ramping up I. INTRODUCTION their use of cryptocurrencies. For example, Face- Before the rise of the Foreign Account Tax Compli- book’s announcement that it plans to issue its own crypto-based payment system (referred to as ‘‘Project ance Act (FATCA) became a ‘‘thing’’ in the early 2 2000s, there were many fishing expeditions by the In- Libra’’) lends credibility to the fact that cryptocur- ternal Revenue Service into learning the methods rencies are here to stay and the government is becom- Americans used to hold funds offshore — sometimes ing more aware of the need to understand how they engaging in tax evasion. I make the distinction be- work and where the risks for non-compliance may be. Against this background, the ‘‘noise’’ we are hear- cause not all Americans with funds overseas have a 3 guilty mind. Some just prefer to diversify or are part ing from the IRS and Congress after a sluggish start of an international family structure. Nevertheless, the around understanding the activities surrounding cryp- methods learned by the Department of Justice and the tocurrency enforcement is akin to the pre-FATCA in- IRS eventually led to Congress’s enactment of vestigative mood. On July 2, 2018, the IRS an- FATCA in 2010. With the rise of cryptocurrencies and nounced a campaign to better understand virtual cur- virtual currencies, the IRS is keen to learn more about the application and uses of these virtual currencies 1 See OECD, Cryptocurrencies: Opportunities, Risks and Chal- and is once again flexing the agency’s investigative lenges for Anti-Corruption Compliance Systems, available at and enforcement muscles to track down non- http://www.oecd.org/corruption/integrity-forum/academic-papers/ compliant taxpayers. Ciupa-Katarzyna-cryptocurrencies.pdf (Mar. 2019); see also The United States is not alone in trying to under- OECD, How to Deal with Bitcoin and Other Cryptocurrencies in the System of National Accounts (Oct. 29, 2018), available at stand the use and taxation of these tech-like financial http://www.oecd.org/officialdocuments/ instruments. On July 21–22, 2018, the G-20 finance publicdisplaydocumentpdf/? ministers and central bank governors met in Buenos cote=COM/SDD/DAF(2018)1&docLanguage=En. Aires, Argentina to discuss a number of international 2 See Facebook Unveils Cryptocurrency Libra in Bid to Re- tax topics, including among them the expansion of shape Finance, Wall St. J. (June 18, 2019), available at https:// wwwwsj.com/articles/facebook-unveils-crypto-wallet-based-on- currency-libra-11560850141. 3 * Sahel Ahyaie Assar is International Tax Counsel at the law See Congressional Letter to Charles P. Rettig, Commissioner firm of Buchanan, Ingersoll & Rooney. The views expressed in (Apr. 11, 2019), available at http://src.bna.com/HhY. this article are those solely of the author. Tax Management International Journal ஽ 2019 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 1 ISSN 0090-4600 rencies and enforce individual compliance.4 One year government regulators, including in the U.S., the IRS, later, on July 26, 2019, to educate and persuade tax- the Department of Treasury, the Securities and Ex- payers with unreported or unpaid taxes relating to change Commission, the DOJ and the Federal Bureau cryptocurrency transactions to voluntarily comply of Investigation, among others. Significant market ac- with the law, the IRS issued a news release titled ‘‘Re- tivity, volatility, and investor interest in the crypto porting Virtual Currency Transactions.’’5 The release space has sparked important interest to evaluate the provides three sample letters (IRS Letter 6173, IRS value and use of these types of assets, including the Letter 6174, and IRS Letter 6174-A, together the federal and state taxation of cryptocurrencies. ‘‘IRS Letters’’) to prepare taxpayers to fully under- A cryptocurrency (e.g., bitcoin) is an electronic stand their U.S. federal tax and reporting obligations. payment system that is based on cryptographic proof, The opening sentence in the IRS Letters alone is remi- permitting parties to exchange the cryptocurrency niscent of FATCA-like inquiries: with each other using the blockchain technology. It [W]e have information that you have or had one or does not require a third-party clearinghouse to vali- more accounts containing virtual currency and date the transaction (such as a bank). A blockchain is may not have met your U.S. tax filing and report- a decentralized ledger of all transactions in a network. ing requirements for transactions involving virtual The blockchain technology permits participants in the currency, which include cryptocurrency and non- 6 network to confirm transactions without the need for crypto virtual currencies. a trusted third-party intermediary. A distributed ledger in a blockchain allows every participant in the net- According to the news release, by the end of Au- work to simultaneously access and view the informa- gust 2019, the IRS will have sent more than 10,000 tion on the blockchain. Cryptography permits integ- letters to taxpayers it suspects may have unreported rity and security of the information ensuring crypto- income during tax years 2013 through 2017 relating graphic functions. Consensus verification is achieved to transactions using cryptocurrencies. Taxpayers are by participants confirming modifications with one an- warned to actively report their holdings, correct any 7 other, thus replacing the need to liaise with a third previous erroneous reporting and calculate the tax. party to authorize transactions. Users who contribute If history is prologue, taxpayers should seriously computing power to a network are referred to as start (if they haven’t already) reviewing their transac- ‘‘miners.’’ Alternate coins are created through ‘‘min- tions using cryptocurrencies and assess early-on (i.e., ing’’ — a process of using computers to devise algo- before the IRS contacts them) what are the correct rithm cryptographic hashes that support blocks in a U.S. federal income tax consequences to transactions blockchain. they have concluded using cryptocurrencies. Bitcoin, a peer-to-peer electronic cash system, was To help bridge a gap between the available govern- first introduced in 2008 by an unknown person or ment guidance and what remains open and subject to group of persons using the pseudonym Satoshi Naka- interpretation — ergo, causing confusion for taxpay- moto.8 Frustrated with the inadequate response of ers’ compliance initiatives — this article provides a general overview of the U.S. federal income tax con- central bankers to the financial market meltdown and sequences and reporting requirements relating to related global recession at that time, a number of fin- transactions involving cryptocurrencies. tech innovators emerged with the introduction of bit- coin as an alternative form of money to solving the II. BRIEF HISTORY OF THE problem of inadequate trust at the central bank levels. EVOLUTION OF To better understand the taxation of cryptocurren- CRYPTOCURRENCIES AND KEY cies, a brief review of terminology is warranted. The terms ‘‘cryptocurrency,’’ ’’virtual currency,’’ and DEFINITIONS ‘‘digital currency’’ are used interchangeably. A ‘‘digi- Cryptocurrency (crypto), also referred to as virtual tal currency’’ refers to an internet-based medium of currency, has been the subject of growing interest by exchange with characteristics similar to physical cur- rencies. ‘‘Virtual currency’’ is a subcategory of digital currency, and is defined by the European Banking Au- 4 See IRS Announces the Identification and Selectin of Five Large Business and International Compliance Campaigns (July 2, thority as ‘‘a digital representation of value that is nei- 2018), available at https://www.irs.gov/businesses/irs-announces- ther used by a central bank or public authority nor the-identification-and-selection-of-five-large-business-and- necessarily attached to a fiat currency, but is accepted international-compliance-campaigns. by natural or legal persons as a means of payment and 5 See IR-2019-132. 6 See e.g., IRS Letter 6173 (July 16, 2019), available at https:// www.irs.gov/pub/notices/letter_6173.pdf. 8 See Satoshi Nakamoto, Bitcoin: A Peer-to-Peer Electronic 7 Id. Cash System, The Bitcoin Project (Nov. 1, 2008). Tax Management International Journal 2 ஽ 2019 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. ISSN 0090-4600 can be transferred, stored or traded electronically.’’ ing home game attendees the ability to pay with cryp- The term ‘‘cryptocurrency’’ is a subcategory of virtual tocurrencies when purchasing tickets for the team’s currency in which encryption techniques are used to raffle endeavors.10 regulate the various generations of units of currency and verify the transfer of funds. A ‘‘wallet’’ refers to III. TAXATION OF a platform where purchased cryptocurrencies from a CRYPTOCURRENCIES — A WIDE TAX digital currency exchange (a platform that permits us- ers to trade their virtual currencies for conventional NET currencies with other users) are stored in a digital wal- let, which in turn stores a public/private key (i.e., a A. Limited Guidance from the IRS digital address) that allows the owner to access, use, or transfer the bitcoin.
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