There has been a growing interest among Free and Open Source Software (“FOSS”) projects in the use of crypto-currencies such as Bitcoin and its myriad derivatives (hereinafter “Bitcoin”). However, uncertainty over the treatment of these currencies by US law has dissuaded developers from from using Bitcoin. This post provides some general guidance on the legal consequences of using such convertible virtual currency.
Please note that different jurisdictions address the issues related to Bitcoin differently. The comments provided in this post are restricted to U.S. law. If you are uncertain of your legal obligations, contact the Software Freedom Law Center or seek other legal counsel.
In the United States, the use of Bitcoin is not considered illegal of its own accord. A number of agencies are currently involved in the regulation of Bitcoin. At the Federal level, the Financial Crimes Enforcement Network (“FinCEN”), the relevant bureau of U.S. Treasury that polices the financial system against illicit usage has issued some guidance on usage of virtual currencies. This guidance broadly explains the obligations for those who deal in virtual currencies in different capacities. The Internal Revenue Service (“IRS”) notice treats Bitcoin units as property rather than currency and subjects them to the general procedures of the tax code that are applicable to transactions involving property. US Consumer Financial Protection Bureau (CFPB) has issued an advisory warning to the consumers that highlights the risks posed by virtual currencies but these guidelines run on the lines of general User Beware guidelines and don’t speak to the legality of virtual currencies. New York Department of Financial Services (NYDFS) is working on Bitcoin Regulations and are receiving comments from the general public until first week of October, 2014.
For the purpose of this post, we shall concentrate on uses of virtual currencies by FOSS projects. Bitcoin usage broadly falls into one of the following two categories: a user or an administrator or money transmitter.
A user is defined as one who transacts with Bitcoin as a virtual currency equivalent (e.g, purchase of goods and services, purchase of another virtual currency or real currency) for the user’s own investment or use. The process by which such a user obtains Bitcoin, whether by “mining”, “purchasing” or “harvesting” is immaterial.
An administrator, an exchanger or a money transmitter are those individuals or entities who are engaged as a business in the exchange, buying or selling of virtual currency for real currency, funds, or other virtual currency.
The most common way in which FOSS projects are likely to use Bitcoin is as a user – using Bitcoin as a supplement or replacement for money when conducting everyday transactions. This includes receiving donations, selling branded merchandise, collecting admission fees for project events, or making payments to equipment and service vendors. Projects that use Bitcoin for these kind of transactions where Bitcoin are accepted or transferred to others in exchange of goods and services are not subject to any special obligations or prohibitions under U.S. law. If a user mines Bitcoin and uses the Bitcoin solely for her own purposes and not for the benefit of another, the user is not subject to any FinCEN regulations.
For IRS ’s purpose, transactions conducted using Bitcoin will be subject to similar tax and information reporting obligations as any equivalent transaction using money. For example, if you pay wages to an employee using any virtual currency, those must be reported on the W-2 form and will be subject to the usual payroll taxes and federal income tax withholding rules.
When transacting with Bitcoin, projects are required to determine the fair market value of any Bitcoin assets acquired or disposed of on the relevant date of the transaction. The appropriate method for determining the fair market value of Bitcoin units will depend upon the particular circumstances. One of the ways that the fair market value of Bitcoin can usually be established is by the current market exchange rate. Many users of Bitcoin, simplify their taxes and accounting as well as minimize their exposure to risk in the volatile Bitcoin market by opting to convert Bitcoin directly into cash upon receipt. There are services that can accept donations for a project and automatically convert them into dollars. You may want to explore such options. Even if projects wish to retain donated or earned Bitcoin for a period they may want to consider employing single-use wallets for each transaction in order to help keep their accounting clear and accurate. Commercial providers offer services for projects and developers who wish to take this approach. Although the services these providers offer can often be convenient, projects must carefully implement their own thorough accounting practices to satisfy their individual needs. Another important consideration for projects using Bitcoin is the fluctuation over time in value of Bitcoin. It is estimated that on any given day, Bitcoin’s price can fluctuate by 5%. The recent 12% fall in the price of Bitcoin is an example of such uncertainties. Unlike cash, the difference between the fair market value of Bitcoin units at the date of acquisition and the date of disposition will represent a loss or gain for federal tax purposes. This means that proper accounting for Bitcoin requires diligent record keeping for all acquired Bitcoin.
Although Bitcoin transactions can occur anonymously it is typically preferable to know more about the identity of your donors, supporters, vendors, contractors, etc. Specific legal obligations will vary depending on the details of the particular transactions at issue and the laws that govern your particular project. As a general matter it is advisable to put in place a policy of maintaining updated contact information of those you transact with for your project’s financial records.
It is important to note that the IRS notice is applicable retroactively. Taxpayers may be subject to penalties for failure to comply with tax law. However, penalty relief may be available to taxpayers if you can establish that the failure to properly file information returns was due to a reasonable cause. If you believe that your project may have acted contrary to this notice in the past you may want to consult an attorney.
If a project or entity is running a business, in the course of which they exchange virtual currency for real currency, funds or other virtual currency, or issue Bitcoin or have the authority to withdraw Bitcoin from circulation, such entity is considered to be a “Money Service Business (MSB)” as per the Bank Secrecy Act (“BSA”). The conduct of such business is subject to elaborate regulations under the BSA. A discussion of those regulations is beyond the scope of this post. If you think that your business qualifies to be considered an MSB, please contact the Software Freedom Law Center or seek other counsel for further advice.
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