In the United States, marijuana still carries federal offenses despite being legalized in some states. Given that the traditional banking industry is regulated by the federal government, most banks have been slow to accept (and service) legal dispensary and related business activity, even if individuals or businesses are legitimate under state law and attempt to comply with all anti-money laundering/banking regulations.
For example, my law firm recently took a call from an individual (let’s call him Mr. X) who manages investments in marijuana dispensaries. He called our firm because we specialize in federal and state tax compliance and have handled a number of civil tax and criminal tax matters involving the marijuana industry.
He was seeking advice on how to run his business despite the fact that his investments in dispensaries (in a legalized state) could not obtain traditional bank accounts. The physicality of the amounts of cash left a number of issues that had to be addressed. Safe storage, expense and security of physically moving the cash to a jurisdiction that would provide for the company’s banking needs, currency regulations on the transport of currency to alternative jurisdictions, etc. His options were not the legal solutions he was seeking, nor could we offer advice as to those options.
Given this is primarily a virtual currency post, I’ll spare you further legal analysis of Mr. X’s dilemma and focus on how his case pertains to Bitcoin.
Is Bitcoin a Legal Solution for Mr. X?
In general, the sale or exchange of convertible currency, or the use of convertible virtual currency to pay for goods or services in a real-world economic transaction should allow for compliance with U.S. banking and tax regulations. Logistically, a fair majority of vendors, customers, shareholders, employees, etc. would need to commit to such an arrangement in order for virtual currency to be recognized as a viable option, though. If this buy-in is achieved and is realistic, the federal tax and reporting requirements for virtual currency would likely accomplish the goals of the anti-money laundering regulations imposed upon banks. Accomplishing those goals would also likely further the virtual currency cause.
However, given the infancy of the majority of marijuana businesses and their trickle-down industries (many of which are cash-run), it is unlikely that virtual currencies are a solution to the problem described by Mr. X at this point in time. Even well-established marijuana businesses still have numerous individuals and businesses that would also need to utilize the currency in order for it to be considered a sound business solution.
While Bitcoin’s acceptance continues to grow on a grass-roots level, we do not yet see the widespread use and acceptance of exchange that is required to provide a practical solution for marijuana industries. Fortunately for Mr. X, his business can afford to retain a tax attorney to advise him on the proper strategies to ensure regulatory and tax compliance if he can just get his employees and subcontractors on board. He may have a solution to his cash-hoarding problems after all*.
For those who choose to take part in any virtual currency transactions, please be aware of the reporting regulations and federal tax implications involved. Seek counsel from a tax attorney who can advise you on tax planning, tax preparation and related reporting obligation.
Reporting Virtual Currency
Payment received in the form of convertible virtual currency is now subject to federal income tax withholding, payroll taxes, and information reporting to the same extent as payment earned in any other manner. The amount reported should be the fair market value of the virtual currency (in U.S. dollars) on the date of payment. When reporting these payments, you should be aware of the following:
- Payments made to an independent contractor in convertible virtual currency worth $600 or more must be reported on Form 1099-MISC.
- If a taxpayer identification number has not been obtained from the taxpayer, the payor must claim ‘backup withholding.’
- Third party settlement organizations (TPSOs) are required to report payments to a merchant on Form 1099-K if the payments to that merchant exceed $200 in a calendar year and the gross amount of payments exceeds $20,000.
- See IRS Notice 2014-21 reporting requirements for convertible virtual currency payments.
- Seek Tax Advice.
Tax and Reporting Penalties for Non-compliance
Taxpayers who have failed to pay tax or file an information return regarding their convertible virtual currency transactions prior to the date of the IRS guidelines (March 25, 2014) may be subject to penalties under Internal Revenue Code Section 6662 or federal investigations, just as they would with other non-compliance risks and penalties.
Those utilizing virtual currency exchanges are wise to pay attention; tax obligations are serious considerations for any business, and for virtual currencies the tax guidelines are new and different than traditional income reporting. It would be wise to hire an advisor (and perhaps a bookkeeper, too).
Things to Watch Out For (Obligatory Disclaimer)
Since your virtual currency holdings are not FDIC insured, you should at least know and trust the people you work with. As with any business, those that deal in virtual currency need a certain level of professional recognition to build their reputation, something that client anonymity cannot provide.
Online exchanges may be forced at some point to report their clients’ accounts, as do banks and brokerage firms, and may even classify these exchanges as financial institutions for purposes of FATCA reporting. In addition, by classifying convertible virtual currency as property, IRS Notice 2014-21 may lead to a situation where cities and states demand that sales tax be applied to virtual currency transactions. All we know at this point is that the IRS has finally taken notice of virtual currencies and that means you should as well.
Finally, this post does not consist of legal advice. Get good advice and be willing to pay for it from an attorney who is informed on the legal implications of virtual currency exchanges.
*Ironic, isn’t it? More money, more problems.
This post was written by Elizabeth Prehn, Firm Administrator of Moskowitz LLP