Bitcoin could become a real problem for tax collectors, experts say. Bitcoin: Tax haven of the future

Stashing money in a Swiss bank account is so passé.

Tomorrow’s tax havens could be fueled by new technology like Bitcoin and Litecoin — online currencies that can be used to purchase everything from coffee to illegal drugs.


The problem for government coffers: There’s no mechanism to ensure that people who make money through such digital currency report the income to the IRS.

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In its fight against tax evasion, the U.S. is largely focused on shining a light into bank accounts held by Americans in other countries. But experts say the rise of Bitcoin, which doesn’t require a bank account, could force the U.S. to rethink its approach.

“It has the potential to become a real problem for tax collectors because Bitcoins have all the traditional advantages of tax havens,” Omri Marian, a professor at the University of Florida Levin College of Law, told POLITICO. “But unlike traditional tax havens, … the operation of Bitcoins is not dependent on the existence of financial intermediaries such as banks.”

Trace Mayer, an expert on Bitcoin taxation, describes digital currencies as “the ultimate offshore bank account.”

“For someone who does want to be creative and avoid taxes, digital currencies are a tool they can use,” said Mayer, who invests in one of the online shops that sell Bitcoins.

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The most popular digital currency, Bitcoin, was developed in 2009 by a programmer or programmers working under the pseudonym Satoshi Nakamoto. Today, it makes up the vast majority of the digital currency economy and has seen prices for each coin jump to $230 in April from $13 in January.

Bitcoins are created through a complex process known as “mining.” When a buyer purchases the coins from an official exchange service, the sale is added to a ledger which then creates new coins. At that point, the money can be used like traditional currency at participating online retailers.

The digital currency market is relatively small for now — estimated at about $2 billion.

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But Washington is beginning to pay more attention to virtual currency and its implications.

Senate Finance Committee Chairman Max Baucus (D-Mont.) and Utah Sen. Orrin Hatch, the tax-writing panel’s top Republican, asked the Government Accountability Office to study the issue.

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The government watchdog issued a report in June that said the IRS should issue informal guidance for taxpayers on the reporting requirements for virtual currencies such as Bitcoins. The report warned that virtual economies pose a real-world tax compliance risk, even if citizens aren’t purposefully shielding their money.

“Taxpayers may be unaware that income from transactions using this type of virtual currency may be taxable,” the paper said. “Or if they are aware, uncertain on how to characterize it.”

In response to the GAO report, the IRS said the agency would evaluate the compliance risks and could provide more information for taxpayers. An agency spokesman declined to elaborate on the status of those guidelines.

Other Washington regulators are trying to address Bitcoin and other digital currency.

The Treasury Department bureau designed to combat money laundering — the Financial Crimes Enforcement Network — released guidance in March that attempted to clarify which virtual currencies should register with the government. But the guidance only created more questions.

“The guidance is kind of vague as it applies to a lot of the different players in the Bitcoin economy,” said Jerry Brito, a senior research fellow at George Mason University’s Mercatus Center. “So you’re beginning to see folks in the Bitcoin community calling for FinCEN to clarify the guidance.”

The U.S. is not the only country trying to figure out how to regulate the money. Germany made Bitcoins a legal tender in 2012 and earlier this year exempted the money from its capital gains tax.

The Bitcoin debate comes as the U.S. moves to implement the Foreign Account Tax Compliance Act, which seeks to crack down on tax havens by requiring offshore banks and financial institutions to report income earned or invested abroad by U.S. taxpayers.

There’s no proof that the extra scrutiny given to traditional tax havens gave rise to Bitcoins. But with banks beginning to turn over their account information to the U.S., the online currencies can provide the secrecy tax evaders require.

“You don’t have to go through a third party that can be subpoenaed or that could face any type of fine for noncompliance or could be shut out,” Mayer said.

Marian said the Bitcoin economy is already seeing signs that the currency is being used to hide wealth. Some buyers, for example, will use multiple bank accounts to buy trivial amounts of the coins, which are then sent to a central account.

“These are characteristics of individuals who want to avoid paying taxes,” he said.

Zachary Warmbrodt contributed to this report.