Toolbox: What To Consider When Managing Bitcoin
The world economy is at an inflection point where knowledgeable investors, companies, and professionals cannot ignore Bitcoin, crypto assets, and Blockchain technology. This article will discuss the various legal, business, accounting, and tax issues that you need to understand to stay competitive in the modern world.
Since Bitcoin operates on Blockchain technology and public/private key cryptography, the loss of cryptocurrency keys (“private keys” effectively act as a password for spending one’s crypto assets) means a total loss of one’s investment. As many companies are beginning to use and invest in digital assets, companies need to take steps to make sure that their investments and transactions are secure, legal, and fully integrated into their accounting, record keeping and internal control systems.
As companies begin to transact in digital assets and use Blockchain technologies, additional legal questions and challenges will begin to arise for those companies and their advisors. If a company receives as payment a Bitcoin that represents proceeds from a criminal activity, what is that company’s responsibility to investigate the source of their customer funds? When transactions are conducted using cash, there is no way to determine how many times a particular $20 bill was used to purchase heroin. A Bitcoin’s history, however, can be readily viewed by anyone with an internet connection.
There are many other legal and regulatory issues that companies may need to consider, including:
- Whether a company’s cryptocurrency holdings are appropriately covered under its insurance policies;
- Exchanges and other financial institutions may need to comply with state-by-state “Money Service Business” statutes;
- The Commodities Futures Trading Commission has declared Bitcoin to be a commodity, and therefore the CFTC regulates the Bitcoin Futures market;
- Financial services entities may need to consider how their usage of cryptocurrency fits into their requirement under the Bank Secrecy Act;
- Some states have passed their own laws related to cryptocurrency, such as New York State’s “Bit-License.”
Fraud And Criminal Activity
Until recently, Bitcoin and other digital assets have had trouble shaking their bad reputation. Physical currencies such as the US dollar have had significant problems with fraud and money laundering, and Bitcoin is no different. Any crime that can be committed using dollars can also be committed using cryptocurrency. As such, cryptocurrency fraud criminal activity has reached all areas, ranging from ransomware to tax fraud and terrorist financing.
Cryptocurrencies have been of particular interest to criminals because of its semi-anonymous nature. Individuals can hold and transact in Bitcoin and other cryptocurrencies without the use of third-party banks or financial institutions, allowing for an increased level of secrecy. Although Bitcoin is sometimes said to be “untraceable,” that is far from accurate since forensic accountants can use many techniques to gather information from the publicly available Blockchain data and other sources.
In 2014, the IRS released IRS Notice 2014-21 announcing that cryptocurrency is to be treated as property for income tax purposes. Since then, the IRS issued subsequent guidance through Revenue Ruling 2019-24 and answers to some frequently asked questions. The IRS has stated that they intend to pursue additional enforcement efforts against individuals who have not reported their cryptocurrency transactions.
More recently, the IRS added the question, “At any time during 2019, did you receive, sell, send, exchange, or otherwise acquire any financial interest in any virtual currency?” to Schedule #1 of the 1040 tax return. In 2020, the IRS moved the question front and center on the first page of all individual income tax returns, right above the section where the taxpayer lists dependents.
Cryptocurrency owners should know that hiding their transactions will open them up to potential criminal action by the IRS. However, with the right tax advice and proper planning, there are legal ways to reduce one’s taxes. For example, Bitcoin is not a stock or security, so it is not subject to “wash sale” rules. In addition, there is a substantial tax break for donating appreciated assets to charity.
Cryptocurrency has become a hot topic in litigation. Many companies have used Blockchain technology to create new crypto assets known as “tokens,” which the companies have sold to investors to raise capital. This process is referred to as an Initial Coin Offering (“ICO”). Since companies sold these tokens to investors, many of the ICOs fall under the purview of the Securities and Exchange Commission (“SEC”). The SEC and securities attorneys are currently grappling with the applicability of securities laws to digital assets.
The Road Ahead
Bitcoin has progressively evolved from a tech nerd hobby to a favored currency for illegal drugs, to a fringe investment asset class, to a mainstream investment. As more and more individuals and entities start to transact in digital assets, professionals in the legal and accounting field will need to evolve to understand and address new issues and challenges.
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