The crypto FBAR: Implications beyond

The United States Department of Treasury is again sharpening its sword upon crypto. In January 2021, the Department of Treasury’s Financial Crimes Enforcement Network issued Notice 2020-2. The Notice states that FinCEN intends to amend its regulations concerning the reporting of foreign financial accounts to include digital currency as a type of reportable account. 

In simple terms, this means FinCEN may soon require crypto users to file annual Reports of Foreign Bank and Financial Accounts, or FBARs, for crypto held on foreign exchanges. The effects of such an amendment are expansive. A mere paragraph long, the notice carries several implications that affect crypto owners — well beyond a simple FBAR report.

Presently, cryptocurrency accounts are not reportable accounts within the meaning of the FBAR regulations. Should a change occur, crypto owners — already burdened by heightened Internal Revenue Service focus — would then be required to report annually the highest aggregate balances of their crypto accounts to FinCEN.

This requirement is in addition to the crypto disclosure question on IRS Form 1040, Individual Income Tax Return. Along with disclosing the highest aggregate balance, the crypto owner must also disclose the custodian of the crypto, its location and the crypto account number (or some other identifier). Assuming the reporting rules stay the same, the crypto accounts would be reported on FinCEN Form 114 and filed electronically by April 15 of the following applicable year (like tax returns).

Crypto FBAR requirements

But not all crypto accounts would be reportable. The FBAR filing requirement only applies to foreign accounts whose balances exceed $10,000 (in the aggregate) for the tax year. So, if two accounts have a combined account balance greater than $10,000 at any one time, then both accounts are reportable.

For example, if one holds $4,000 of Cardano (ADA) and another has $7,000 of Bitcoin (BTC) on a non-U.S. exchange, both holdings are reportable because, in the aggregate, they exceed $10,000. Therefore, crypto owners should carefully track the fair market values of their crypto accounts throughout the year in a volatile market. What is worth $5,000 today could exceed the $10,000 threshold in a short time.

Penalties and failures to disclose

And failure to disclose a reportable account is a fool’s errand. FBAR penalties are draconian. For “non-willful” failures to file FBARs, the penalty is $10,000 per failure. The courts are currently in flux over whether that $10,000 is per account per year or just per FBAR due.

The IRS — predictably — takes the former view. If the $10,000 penalty is per account per year, it is easy to see how FBAR penalties can easily exceed the actual balances of the accounts themselves. That is, a taxpayer could pay more in FBAR penalties than the worth of their accounts. And for “willful” non-compliance, the penalties teeter on unconscionability. They prescribe a civil penalty for willfully failing to file an FBAR of up to $100,000 or 50% of the balance in the account at the time of the violation. Willful violations include both knowing and reckless nondisclosures.

There is yet another requirement birthed from the possible changes in the FBAR regulation. At the bottom of Schedule B of Form 1040, there is a series of foreign bank account questions. Presumably, if crypto accounts fall within the new FBAR regulations, then an FBAR-reporting taxpayer would also need to answer the Schedule B questions in the affirmative. And answering in the negative is not a good choice. Untruthfully answering “no” to the Schedule B foreign bank account questions is considered “willful” behavior in the eyes of the IRS.

And importantly, unlike the FBAR rules, there is no account value threshold with the Schedule B questions. Voluntary foreign bank account disclosures do not begin and end with the filing of an annual FBAR. If applicable, the taxpayer must also answer…