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Rules & Regulations for U.S. Citizens

Terms & Laws U.S. Citizens need to know before engaging with Digital Currency

Disclaimer: This is not legal advice. This is based on only knowledge that I have acquired online in my search for staying within the law. I am no legal expert. Make sure to double check and verify information written here for yourself; as a bonus seek legal counsel if you intend to deal with digital currency: particularly with any medium that has identified you as a holder of digital currency or if you attempt to realize your gains via your bank account. Be aware that in the U.S it is necessary to exercise caution, tread carefully to know how government officials will regulate and treat the new currency. Will it view anyone who uses it as a criminal, make it difficult and expensive to comply, or be open and friendly towards users.

The following is a list of terms and concepts that I not only have had to learn and am still learning but that I recommend that any U.S. citizen engaging with bitcoin get into. Digital currency is part of a grey market and is becoming more and more regulated as time passes state by state, country by country.

  • Terminology
    • Money Laundering – is an umbrella term that once only meant the process of transforming profits of crime and corruption into legitimate assets, now includes forms of financial and business crimes, evasion of taxes and international sanctions to name a few.
    • PFIC – a passive foreign investment company. Where 75% of gross income is poassive derived from investments rather than company’s regular business operations, or, based on the assets where at least 50% of the company’s assets are investments (Trusts, Insurance, Hedge Funds, and/or etc) that produce income in the form of earned interest, dividends or capital gains.
    • Civil Forfeiture (Bank Secrecy Act) – originally designed to target drugs now being used to seize assets of anyone who doesn’t report their cash and digital currency earnings. It allows IRS and authorities such as police to confiscate money and property without a warrant from law-abiding citizens. Burden of proof is up to the individual. 80 – 90% of these scenarios where police confiscate assets are kept and sold by the police.  (read here and here).
    • Liens & Levies – A lien is a legal claim against your property to secure payment of your tax debt, a levy actually takes the property to satisfy the tax debt.
    • Worldwide tax – income tax system imposed not just on local income but on worldwide income. Meaning people who live abroad must pay the local taxes of the country they are in, plus the taxes of the U.S. fed. government based on their income for the privilege of holding an American passport, even if they are dual citizens.
    • Tax Event – A taxable event is any event or occurrence that results in a tax liability. All investors or parties that pay taxes experience taxable events. Two examples of taxable events are if an investor receives dividends or realizes capital gains
  • Federal Laws & Rules –
    • Patriot Act – surveillance laws that allows authority to monitor phone and email communications, collect bank and credit reporting records, and track the activity of Americans on the Internet. It requires similar money transmitter businesses like Paypal to collect and identify information on consumers. Information gathered is reported to the IRS when income reaches over 10k and during IRS investigations included in reports to stop Money laundering.
    • FATCA – Foreign Account Tax Compliance Act – is a 2010 United States federal law designed to target American expatriates, to enforce the requirement for United States persons including those living outside the U.S. to file yearly reports on their non-U.S. financial accounts to the Financial Crimes Enforcement Network (FINCEN). Fatca makes it mandatory for foreign banks to report American Citizen account holders to the IRS, the same way American banks do or face sanctions. Attempts to repeal and challenge FATCA (HR 2054) as of 2017 have been put into place but no ruling as of yet.
    • Bank Secrecy Act – requires financial institutions to assist U.S. gov’t agencies to detect and prevent money laundering. Requires financial institutions to keep records of cash purchases, file reports of cash purchases of more than 10k, and to report suspicious activity that might signify money laundering, tax evasion or other criminal activities in the form of structuring. Made it a requirement for banks to file SARs and CTRs.
    • US Bill 1241 “Combating Money Laundering, Terrorist Financing, and Counterfeiting Act of 2017”– bipartisan bill adds digital currency to civil forfeiture laws, for assets over 10k. Requires travelers both u.s. and non u.s. to declare digital currency at US border just like they would cash. Failure to report holdings will result in civil forfeiture of all assets and up to 10 years in prison. Inside the report is a mandatory requirement that the DHS (Department of home security), U.S. customs and Border Protection agency develop an infrastructure for blockchain monitoring. Note that this bill includes Cash, Digital Currency, Prepaid Phones, Vouchers, Coupons & Gift Cards — electronic and physical.
  • Business Licenses “Exchanges, Banks, Payment Systems, etc”
    • Money Transmitters (State) – In the legal code of the United States, a money transmitter or money transfer service is a business entity that provides money transfer services or payment instruments. Money Transmitters in the US are part of a larger group of entities called Money Service Businesses or MSBs. Many people who sell their own bitcoins peer-to-peer example via Localbitcoins, have often found themselves in some jurisdiction being caught up in sting operations by police who try to get them for operating without a money transmitting license. Like ‘insurance licenses’ these licenses vary from state to state and are expensive to purchase. The average cost of a Money Transmitter License is 176k. Keep in mind in some states it is illegal for children to mow lawns or sell lemonade without a business license.
  • Laws
    • FAST ACT, Fixing America’s Surface Transportation Act, H.R. 22 – gives IRS power to revoke passports for Tax debts owed over 50k including interests and penalties.
    • Civil Forfeitures –
    • KYC. Know your customer (Patriot Act) – is the process of a business identifying and verifying the identity of its clients. Designed predominately to tackle Money laundering such as those attempting to evade taxes and other criminals.
    • AML. Anti-money laundering – set of regulations and controls that require financial institutions to prevent, detect and report money laundering activities. It is up to individual employees and institutions to detect and report suspicious activities.
  • Federal Government Regulating bodies
    • SEC – U.S. Securities and Exchange Commission (SEC) is an independent agency of the United States federal government. The SEC holds primary responsibility for enforcing the federal securities laws, proposing securities rules, and regulating the securities industry, the nation’s stock and options exchanges, and other activities and organizations, including the electronic securities markets in the United State
      • ICOs, IPOs and similar Initial Coin Offerings, tokens that are premined and offered similar to stocks and shares fall under SEC jurisdiction. SEC is currently looking for ways to regulate the cryptocurrency ICO market. Some ICOs launched have tackled this by barring U.S. citizens from participating in ICOs similar to foreign banks not taking U.S. customers.
    • FINCEN – views digital currencies as currency. They regulate banks and exchanges not so much the individuals but do share data with the IRS.
      • FBAR, Foreign Bank and Financial Accounts / Fincen Form 114 – related to Form 8938 but reported to Fincen for reporting foreign financial accounts. If you have a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other type of foreign financial account (including foreign insurance) that exceeds certain thresholds, the Bank Secrecy Act requires you to report yearly to the Department of Treasury.
      • FinCen Form 112, Currency Transaction Reports (CTR) (Bank Secrecy Act)– deposit, withdrawal, exchange of currency of more than 10k. Multiple transactions must be treated as a single transaction if conducted by or on behalf of the same person.
      • Suspicious Activity Report (SAR) (Bank Secrecy Act)– banks must file a SAR for any suspicious transactions relevant to possible violation of law or regulation. (all banks and exchanges are required to develop a way to detect suspicious activity).
    • IRS – views digital currencies as property. Their main concern is tax collection and enforcement.
      • Form 8621 – tax form that PFIC investors are required to fill out, is lengthy and complicated taking up an estimated 40 hours to fill out. Advised to have Tax professionals complete the form.
      • Form 720 – for those who own a business or shares within a business that deals in goods and services subject to the excise tax (Form 8833 if form 720 does not apply due to treaty-based exemptions)
      • Form 8938 – Report of FBAR, any foreign financial asset must be reported with this form. fine for not filing 10k ( 50% of your account values whichever is greater), including 100k for those who are found to willfully not file. (included as penalties)
      • IRS section 1031
        provides an exception allows you to postpone paying tax on the gain if you reinvest the proceeds in similar property as part of qualifying like-kind exchange.
    • Department of Homeland Security / U.S. customs and Border Protection agency – regulates trade, customs, immigration and travel. It’s main role is to prevent criminals from entering the U.S. illegally along with other contrabrand issues.
      • See US Bill 1241.
  • Legal Counsels
    • CPA, certified public account – specifically one in cryptocurrency.

Blockchain Surveillance “Tools” & Reporters

Many exchanges and services such as Coinbase already monitor incoming and outgoing transactions. Circle as an example used to terminate accounts of anyone who sent money to localbitcoins. Coinbase forbids people using their bitcoin for gambling and likewise terminated the accounts of anyone who were caught sending money to those places. Think of digital currency just like your bank account and connected credit/debit card. Once you link identifying information to it digital currency leaves a paper trail, where you send your money can be followed.

An example of what that might look like can be found here.

Centralized Exchanges are mandatory reporters, those regulated in the U.S. are bound by AML and KYC laws. These laws require that they report to FinCen and SEC who shares data with the IRS. Exchanges are required to ask for your passport, driver’s license and SSN to abide by reporting requirements, and with new bills like U.S. Bill 1241 passing it is only a matter of time before Exchanges are required to cooperate with US Customers and Border Protection, and the Secretary of Homeland Security.

At any point where you are:

  • required to identify yourself
  • purchase bitcoin without using a VPN (i.e. linked to your IP address)
  • purchase bitcoin linked to an email account linked to you
  • did service or gave someone service in exchange for digital currency and they reported it and you on their tax returns

That is data stored in the blockchain forever.

How the Government knows about your Income

Primary Method #1. Being reported via Centralized Choke points (Exchanges, Hot Wallets & Banks) who monitor your transactions. Your bank account is another example. If you use your credit or debit card to make any purchase of bitcoin online. Whenever money exits from a mandatory reporter to another mandatory reporter you are on the radar. Even if you manage to go off radar at some point you have to bring your money to the surface. If you attempt to disguise the money you will be considered evading taxes and seen as a money laundering. Some online wallets may also be a possible target if regulations are put in place that require them to report the same way Exchanges do.

Primary Method #2. People spending a lavish amount of money. When the IRS does a comparison of your net worth compared to how much you’re spending. If you say you only have 10,000 but were able to purchase a 25,000 car out of pocket then they know you’re lying.

Other Methods. Blockchain surveillance & Whistleblower programmers. Anyone you talk to or work with could report you, and blockchains can be monitored both by exchanges, wallets, and law enforcement. There are tools that already do this and some organizations already doing this.

Consequences of not Reporting

With Civil Forfeiture it’s also possible to have your things confiscated with or without reporting if digital currency is treated similar to the way cash is treated. Where having a large sum of cash is considered suspicious.

  1. Civil Forfeiture – all assets and property, not just the money you are owed, but your house, car, bank accounts etc will be seized and sold.
  2. Penalties, Fines & Interest – they can add more penalties and fines that accumulate per year
  3. Imprisonment – variables times on how long
  4. Close down your business
  5. Garnish your wages
  6. Contact your friends, families and employers
  7. and more

While the police and other government bodies can take everything you own the IRS has a list of property that is protected from seizure (Section 6334):

  1. Furniture and household goods up to $7,720 in value;
  2. Tools necessary for the trade, business or profession up to $3,520 in value;
  3. Clothing and school books necessary for taxpayers family;
  4. Undelivered mail
  5. Wages necessary to pay court-ordered child support;
  6. personal residences if the balance owed to IRS is 5k or less.

And while the IRS may be short staffed and unable to handle their work load law enforcement (police) and DHS are more of a concern when it comes to civil forfeiture and being searched.

Countering Blockchain Surveillance

The only counters for this:

Where you Receive your Digital Currency

  • No Account Required Exchanges (altcoins)– sending money through digital currency only exchanges like Shapeshift (shapeshift is low-volume). Changelly is high volume but requires an email account, and ID for dealing with cash.
  • Peer 2 Peer (Bitcoin only) – use localbitcoins or another p2p place. (be wary of money transmitter licenses and scams). Often sells at a premium and requires physically leaving your home. Slow and cumbersome.
  • Decentralized Exchanges (Low volume/liquidity)– there are currently no good, high volume decentralized exchanges but this may come to change. They often require cumbersome software, have low volume and liquidity. Keep an eye out for NVO.io which may change this.
  • Bitcoin ATM (High Premium) – also sells at a premium, but another option. Most altcoins are easier to get with bitcoin, DASH ATMs etc. aren’t as readily as available.

What Type of Digital Currency You Use

  • Purchasing Privacy-Centric Tokens – Dash, Monero, Zcash, and others.

Bitcoin has proposed to add privacy features to it, one example being “Dandelion”, but it still has to work through its scaling and decision making issues.

Where & How you store your Digital Currency

  • Wallets – sending money to wallets with built-in anonymizers (like the Stratis Breeze wallet) or using wallets that allow you to discard and use a different address per transaction. Using hardware wallets, multifactor, and protecting your keys. Essentially there is no way for your cryptocurrency to be confiscated without you relinquishing your keys, so protecting your keys alongside the wallet you choose for your digital currency makes a big difference. Research Wallet Security for Cryptocurrency.

Where/How You Realize Your Gains

  • All Methods that seek to realize gains under the radar is likely to be considered part of the shadow economy and likened to tax evasion. When it comes time to realize your gains seek legal counsel before you do so to best know how to do so. The fees will take a bite of your earnings but if the gains are truly substantial enough to warrant concern, it is worth it.

Countering Civil Forfeiture

Summary: Don’t do drugs, be vigilant, know your rights to avoid incriminating yourself, and keep your assets out of reach if they do.

Main Methods of Civil Forfeiture:

  1. Traffic Stops –a popular method for law enforcement to stop people. Driving within the speed limit, making sure headlights are on and working. Being extra vigilant of state laws when driving out of state. Be polite when officers are speaking to you. Know your rights but don’t be obnoxious about it, keeping hardware wallets and cash out of sight, not giving probable cause to be searched. Keeping your car well maintained. Due to the  4th Amendment states don’t need a warrant to search your vehicle but must have probable cause, such as seeing paraphernalia in plain site, a warrant for your arrest, or you are behaving suspiciously.
  2. Real Estate – preventing inviting people into your home or participating in criminal activities predominately related to drugs (esp. marijuana).  There are conditions where police are permitted to enter and raid your home without a warrant, looking for a criminal who has entered the home or smelling marijuana are often the reasons.
  3. Foreign Trusts/Bank accounts– many people look to foreign trusts such as the Cayman Islands. Though it’s true the Government cannot control foreign trusts, and that trusts have more freedom than businesses; many people have gone to prison as a direct consequence of not voluntarily giving up their assets for seizure.
  4. If Bipartisan US DHS bill passes, then Coming Soon (crossing the border)

Other Solutions & Summary of Basic Tips

  1. Become a Perpetual traveler/World Citizen/Flag Theory  – see link.
  2. Participate Little – Participate so little in the traditional economy that the government pays you no mind. Be less materialistic have less. (when this method is used with Flag theory it can be very powerful)
  3. Don’t broadcast what you do on social media and blogging platforms – specifically where your real name or identity is linked. Be aware that this could be used in an audit against you and that friends and family who want a prize could report you whether you have realized your gains or not. Keep what you trade on a need to know basis: between you, your lawyer, and select people to who you seek advisement from. Even sharing the news with family can be a problem (as they may want to brag or want a piece of the pie). This is recommended not only to stay off the radar for having your digital currency and all assets taken without a trial, but, can also prevent making you a target of theft and even hackers.
  4. Report Everythingplay the game to win the game; be ahead of the game and report every detail that they want to know, comply no matter how burdensome or difficult. Get a legal adviser and an accountant, as it can take more than 40 hours to put together information. (this burden may be an attempt to deter people from digital currency).
  5. Avoid Marijuana on your property at all costs – Marijuana is legal in some states but illegal according to the federal government. Many of these violations and probable causes are related to guns/weapons, drugs (esp. marijuana which has a strong smell).
  6. Keep vehicle maintained, drive the speed limit – When you travel know the laws of the state you are traveling in as they target out of state drivers the most.
  7. Be as polite as you can be – know and exercise your rights but don’t make law enforcement’s job difficult. Their job is already challenging, they deal with corruption within their ranks and hatred from people who mistrust them and commit illegal acts outside their ranks. Some people in a position authority aren’t nice people, but others are, they all get blanketed together. They are trained to view life in black and white manner, not to question. Treat them like a human being, keep hands on the wheel when speaking, keep your car clean and up to date. Obey their orders and never physically resist, if you need to fight — do so in court, like a politican. Mindset matters, approach from a place of compassion and understanding no matter which side of the fence you are on. It will show through your tone and responses.
  8. Be Legally Prepared – Have a dash cam if necessary, a memorized number, and a legal fund in case you need to hire an attorney. Avoid Public Defenders at all cost. The court systems are bureaucratic and not designed with you in mind, so just prepare for that, like a politician. Keep some assets offshore (but remember the law requires you to report and pay taxes on them over a certain amount).

Know Who You Are Dealing With

Understand that there are different departments with different goals, who arise in different circumstances. Most of the laws that allow for civil forfeiture were designed to tackle drug pins. Money laundering  laws were meant to target drug lords, prostitution rings, and organized criminal groups. Local law enforcement who participate in raids and who search vehicles, their laws focus on drugs and anything related to those drugs. They aren’t looking for financial white collar crimes (that’s the IRS’ job). Digital currency is likely to be added to the expanded money laundering laws that also looks at cash suspiciously. Cash does not leave a paper trail the way digital currencies and debit/credit cards do. There are other agendas at work that use the drug war to piggy back their own agenda.

Expanding the definition of money laundering to include those who evade taxes makes the IRS’ job easier. Discouraging people from holding cash and digital currencies that compete against financial institutions which produce, own, and control money and the economy is another agenda. See The Shadow Economy/Black Market, which  includes not just drug lords and prostitution rings but any person accepting cash under the table.

In any case local law enforcement are looking for drug, weapon and human trafficking related crimes. While the IRS is looking for tax evaders. Knowing who is approaching you, when they would approach you, and under what circumstances help. The expanded laws are now being used to tackle people when they are traveling. It may be that you can’t carry your laptop on board a flight and so on. Things that fall under DHS and border control, and what they are trained to look at and prohibit. Learn their procedures.

  • DHS/Border Control/etc – tackles people who are traveling, focused on preventing drugs, organized crimes, and contraband (anything deemed contraband). My basic understanding is that they rely on what they find in your luggage and searches of your records. Typically people are scanned and singled out for deeper searches if they feel they need to do a deeper search. The no fly list, sanctioned countries, crossing borders etc. may be when these people come into play.
  • IRS – tackles people who evade taxes, they are short staffed, but focused on preventing financial crimes. They rely on institutions and banks to report your actions, typically using tools to cross-check records before flags come up.
  • Police – focus predominately on drugs, typically are found on the highway patrol or are called to the scene. They rely on what they physically see. While they have tools to inquire more about a person, my understanding this is done only after they have seen things that they deep suspicious based on ‘sight’.

Handling Taxes

Digital Currency tax is complicated. Simply buying a cup of coffee is a tax event. For the most part bitcoin and digital currency is taxed as property, like-kind may or may not count for altcoin trading, IRS mainly cares about gains being realized (not realizing your gains and waiting for a year can decrease the rate of tax). Because digital currency is so complicated using a bitcoin tax service or hiring an account is often necessary.

It helps to understand that IRS taxes all income that you earn. Here’s a list of what is nontaxable vs. what is in everyday life. Gifts, rebates, child support, and essentially anything not meant to be income are used as income are not taxable. Anything meant to be income including the poverty trap “lottery” are taxable. The IRS tries to keep any loop holes out of the system. Cash and digital currency which the IRS loses billions of revenue through the underground/shadow economy takes a big bite out of their revenue so they are looking to cover up those holes.

Tax evasion is illegal, tax avoidance is legal. 10k is the golden number because the bare minimum amount of money for a single person without dependents or spouse is 10k. After that point the money you earn is taxable. When it comes to digital currency realizing that just owning digital currency let alone the mess of trading it can make you an easy target. When it comes time to realize your gains I recommend seeking legal counsel and an accountant.

One possible solution is not to realize 10k gains in a year, and look to figure out ways to reduce your tax burden. I’d recommend studying how the wealthy do it.

What This Means for you

U.S. citizens might not be allowed to participate in some ICOs due to restrictions, some exchanges may not except some people from certain states or countries. You may  end up having to fill out complicated and lengthy tax forms, similar to PFIC that require you report your holdings of digital currency, just like foreign offshore accounts.

Pay attention to regulations and laws in the news. They change from day to day and vary from state to state, the federal government, and even from country to country.

Recommendations: While I do not recommend breaking any laws. I do recommend avoiding exchanging more than 100 – 1k on an exchange that has your information, until rules and regulations both federal and local are made clear. The rules and regulations can either be encouraging or antagonistic. Keep your earnings that are on the radar small enough that they are of little interest to the big fish they want to catch, and do not realize your gains (your larger earnings) until you are able to afford a legal counsel who can help you once you enter back into radar. I recommend thinking like a wealthy person who wants to reduce their tax liability but not evade it. This will require an account for the increased tax reporting burden, a legal adviser, incorporation/trust (legally compliant tax haven) (added reporting requirements, legal adviser and accountant apply). Note that a tax haven in this sense isn’t to evade taxes but to make civil forfeiture and liens difficult, though also note failure to comply with court requests can put you in prison, hence you need a legal adviser.

Alternatively when you realize your gains pay up all the money the tax accountant says you might owe (without trying to reduce the tax). You will likely be audited the higher your income bracket is and if you’re on their list and get flagged. You’ll owe more but it’s simpler.

It’s likely I missed some things, possible there are some inaccuracies. But hopefully that gives people a good starting point for their own research.

I will update this or post an update if it needs modifications or clarifications.