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Bitcoin Might Make Tax Havens Obsolete

Bitcoin offers the tantalizing prospect of hiding untaxed income from the government without relying on foreign financial institutions or your mattress
June 22, 2016, 7:00pm
Bitcoin, in physical form. Image: Antana/Flickr

For tax evaders stunned by the leak of the "Panama Papers" maintained by the international law firm Mossack Fonseca, bitcoin could be the next big thing.

Even as governments around the world have begun cooperating to nab suspected tax cheats, virtual bitcoin wallets filled with the cryptocurrency possess the potential to become what University of California-Irvine law professor Omri Marian has dubbed "super tax havens."


These wallets exist in no physical jurisdiction, are not subject to taxation at the source, and do not require the assistance of expensive financial intermediaries such as Mossack Fonseca to administer. As more disenfranchised laborers disappear into the underground gig economy, exchanging their skills for money, bitcoin offers them a convenient end-around for the traditional income reporting demanded of employees and independent contractors.

Individuals who sell illegal drugs online or engage in other illicit activities, such as completing math homework or writing term papers for other students, now regularly request payment in bitcoin and filter their communications through encrypted e-mail networks such as Tutanota.

"It's a very easy way to optimize your wealth," explained a computer programmer who supplements his day job by doing computer science projects for college students. "They tell me what they need, I deliver the service, and no paper trail is created. I use Blockchain for payments and, really, I'm at a point where I could quit and do this full-time."

In addition to turning thousands of middle-income people into professional tax evaders, bitcoin could theoretically allow wealthy speculators to complete complicated commercial transactions, such as tax-exempt stock and gold-swapping trades that involve buying agents acting as "straw men" by using local currencies to facilitate the exchange.


So far, there are no particularly effective enforcement mechanisms that would allow state and federal revenue services to track the online movement of bitcoins. This creates a tremendous opportunity for tax evasion: cryptocurrency advocate Trace Mayer estimated that if even 1% of funds currently sitting in offshore accounts were transferred to bitcoin, the value of this virtual currency could increase substantially. Since the number of Bitcoins in circulation is currently capped at 21 million, if these billions of offshore dollars migrate to that cryptocurrency, the worth of a single bitcoin could rise from $580 to nearly $3 million.

"Although some people might think that stockpiling bitcoins is a shrewd strategy, behaviors such as underreporting income, not reporting income, and living well beyond one's means can trigger a tax audit, and huge investments in bitcoin wouldn't be easy for corporations to make without facing government scrutiny," tax attorney Aaron Richter told Motherboard. "Furthermore, the actual IRS treatment of bitcoin is not especially favorable if you are reporting it as income and paying income tax withholding and payroll taxes, which you must do if you receive bitcoin in exchange for work."

I never signed or accepted the Constitution, but bitcoin is real.

Bitcoin, often treated as a cash substitute in under-the-table sales, is regarded by the Internal Revenue Service as a capital asset, meaning it is subject to the same rules that govern stock and barter transactions when it is finally exchanged for dollars. This is a raw deal for someone being paid in bitcoin who is actually reporting the payment, since they could be taxed on $500 of income only to have the bitcoin they received depreciate significantly in value before they can redeem it.

For bitcoin users who prefer to trade on the black market, the position of the IRS regarding the currency is irrelevant. "As a steroid dealer and user, and somebody who was influenced very much by [objectivists] Ayn Rand and Mike Mentzer, I think of bitcoin as the solution to the problem of illegal tender, our so-called 'paper money' economy," said a personal trainer who accepts the cryptocurrency as payment for his pharmaceutical services.

When informed that the 16th Amendment allows the federal government to tax all income from whatever source derived, the trainer shrugged.

"I don't believe in that because it's fictional. I never signed or accepted the Constitution, but bitcoin is real. It's real money and it can't be stolen from me."