Many US citizens and expatriates are considering digital currency as a tax dodge and a way to hide income and assets from the IRS. The reality of cryptocurrency or “Crypto” and the IRS may shock you. Crypto myths and schemes abound, but what are the genuine facts?
If you are a citizen of the United States or a permanent resident (and a list of other status which qualifies you as a US taxpayer) you are required to file a tax return with the IRS annually which lists all income, worldwide, no matter how or where you achieved it. The United States taxes its citizens on income regardless of the location where it was realized.
The typical pitch from a friend or “those in the know” goes something like this:
You buy digital currency as a tax dodge through an international broker or “exchange.” Ignore the recent massive drop in crypto values as the Chinese government interferes with valuation and distribution. Crypto is not visible to the IRS and therefore your money is tax-free and outside the influence of the US Government.
There is actually the example of a company in the Caribbean who sells passports (read: citizenship) to many island nations in the region. You make a designated “donation” (read: $100,000 or more) plus applicable “fees” and voila – you have “dual citizenship.” These jurisdictions conveniently exempt digital currency from capital gains taxes so you are free (in their theory) to build a massive, tax free fortune. Is it possible to use digital currency as a tax dodge if you are a US taxpayer?
The reality:
You are required to pay US taxes for all international income (including crypto) as long as you are a US taxpayer. If you wish to surrender your passport or give up your US citizenship you should be aware of the US “exit tax.” In order to relinquish your US citizenship you must prove complete IRS compliance for the past five years. Prepare for a microscopic inspection of all your holdings and past 5 years returns by IRS auditors.
In addition, the US charges a small administrative fee of $2,350 to renounce your citizenship and/or relinquish your passport.
FATCA is a trade agreement the US imposed on the world in 2010. In effect, if you want to do business with anyone or any entity in the US your country must agree to the terms of FATCA. Almost every sovereign nation in the world has signed on to this agreement, including most in the Caribbean. FATCA requires all foreign banks, financial institutions, investment houses (read: crypto exchanges) to reveal all account and transaction related information directly to the IRS. There is a reason you were required to provide your Social Security number to set up a foreign account. This is how the IRS finds out about your offshore activities including crypto accounts and activities, all tied conveniently to your own taxpayer ID. IRS computers easily compare international data to US returns to see if the activity was reported. Result: Instant audit.
Roughly two-thirds of all crypto mining operations (especially Bitcoin) are located in China. China controls the supply and valuation for all leading digital currencies. Crypto is not secured by or rooted in any measurable or reliable valuation. There is no insurance or guarantee regarding your digital currency account or its value. In a word: RISK.
Regarding the strategy of using digital currency as a tax dodge – one of the first questions on the IRS 1040 (and other related US tax forms) just under your name and address information is “At any time during (year of return) did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” Your options are “yes” or “no.”
If your answer is “yes” you will have to disclose all of the relative information about your crypto holdings, activities and income. This alone defeats the tax free digital currency strategy.
If you answer “no” you have literally committed perjury (a criminal offense) and immediately expose yourself to a host of civil and criminal charges and extensive stiff financial penalties and interest when the IRS discovers your offshore holdings.
NOTE: penalties and interest have nothing to do with present account balances. They are based upon the highest value of the account at any point (even just one day) in each tax year. If your crypto account reached a high water value of $200,000 and today’s “value” is $20,000 your penalties and interest are 50% of the $200,000 high water mark ($100,000 plus interest) for EACH YEAR you failed to report the income.
While it may be popular or in vogue to consider digital currency as a tax dodge the realities of genuine substantial risk and financial loss are staggering.
We invite you to learn more about the integrated tax, legal, accounting and business consulting services of Allen Barron and contact us or call today to schedule a free consultation at 866-631-3470.
