On June 8, 2021 El Salvador became the first country to adopt bitcoin as legal tender. El Salvador previously used the United States dollar (USD) as legal tender, but decided the strict monetary policy of bitcoin along with the accompanying technology would better serve its citizens. In this publication we briefly discuss the law and then explore whether El Salvador’s decision to adopt bitcoin as legal tender will change bitcoin’s classification from property under the Internal Revenue Code (IRC) to “real” currency.
El Salvador Bitcoin Law
Aside from adopting bitcoin as legal tender, the El Salvador bitcoin law makes clear that exchanges in bitcoin will no longer be subject to the El Salvador capital gains tax. Additionally, tax contributions owed in the country will be able to be paid in bitcoin. The law requires entities to accept bitcoin in exchange for goods or services. However, should an entity not wish to hold bitcoin, the government will assist the entity to convert the bitcoin into USD automatically and instantaneously. Furthermore, the law makes an exception for entities who do not possess the technology to carry out transactions in bitcoin.
The law specifically mentions the country’s intent to provide the necessary training and mechanisms to allow its population to access the ability to accept bitcoin transactions. Only time will tell how pervasive transactions in the El Salvador monetary ecosystem are in bitcoin compared to USD. The law will go into effect 90 days after it is published in the Official Gazette. Assuming this occurred shortly after the bill was passed on June 8, 2021, bitcoin will officially be legal tender of El Salvador by the middle of September 2021.
Does El Salvador’s Decision Impact Bitcoin’s Status as Property under the Internal Revenue Code?
The decision by El Salvador was a big decision with far-reaching implications for its citizens. However, it is possible the decision could significantly impact individuals subject to the United States Internal Revenue Code. All US guidance issued to date have correctly pointed out that bitcoin is not the legal tender of any jurisdiction (see FIN-2013-G001 and Notice 2014-21). This statement will soon not be true!
The US government has used the legal tender distinction as a way to apply a different set of rules to “virtual” currency compared to “real” currency. It has been the government’s view to date that “virtual” currency, a term that currently encompasses cryptocurrency and bitcoin, is property and the taxation rules related to property apply. The question being pressed by El Salvador’s decision to adopt bitcoin as legal tender is does El Salvador's decision have any impact on how bitcoin is treated by the IRS?
The IRC does not specifically define currency. However, the Financial Crimes Enforcement Network (FinCEN), a bureau of the Department of Treasury, has frequently referenced the FinCEN regulations to define “real” currency. The regulations' definition of currency, frequently referred to as “real” currency in FinCEN and IRS guidance, is stated at 31 CFR section 1010.100(m) and includes the money of the United States. Additionally, “real” currency includes the money of any other country that satisfies the following criteria:
- Is designated as legal tender
- That circulates
- Is customarily used and accepted as a medium of exchange
- In the country of issuance.
The remainder of this article will analyze El Salvador’s new bitcoin law to determine if bitcoin will now be considered a "real" currency based on the four criteria listed above.
Is designated as Legal Tender
The El Salvador bitcoin law specifically states that the country is designating bitcoin as legal tender. Additionally, the law is following the commonly used definition of legal tender. According to Merriam-Webster legal tender means “money that is legally valid for the payment of debts and that must be accepted for that purpose when offered.” The El Salvador bitcoin law has specific articles that address the topics required by the legal tender definition. Therefore, it is hard to dispute that this part of the “real” currency definition is satisfied by the El Salvador law.
That Circulates
To meet the “circulates” criteria bitcoin should be moving in an orderly manner throughout the El Salvador monetary ecosystem. The law clearly states that the country will accept bitcoin as payment for taxes. However, more time will be needed to see how much bitcoin circulates throughout the ecosystem. The more widespread and ubiquitous the adoption is in the country, the more likely this part of the “real” currency definition will be satisfied. The monetary ratio of transactions and taxes paid in bitcoin verse USD will be informative for this inquiry once bitcoin is official legal tender in El Salvador. Additional factors to examine would be the country paying wages exclusively in bitcoin and settling outstanding debts in bitcoin.
Is Customarily Used and Accepted as a Medium of Exchange
Similar to the “circulates” criteria above, we will have to see how common bitcoin is in the El Salvador monetary ecosystem in the coming months. While the law requires bitcoin to be accepted by entities in El Salvador, the law excludes that requirement on entities who do not have the technology to carry out bitcoin transactions. Furthermore, El Salvador will automatically and instantaneously convert bitcoin into USD for entities that wish. While bitcoin is clearly going to be a part of the El Salvador monetary ecosystem, only time will tell how common bitcoin transaction will be in the country’s monetary ecosystem. Similar to our discussion related to the “circulates” criteria above, the monetary ratio of transactions in bitcoin verse USD will be an important metric to assess whether this criteria is satisfied.
In the Country of Issuance
While the fourth criteria has not been separately discussed in government guidance to date (instead it has been included as part of the third criteria), the word issuance could be a word the government focuses its analysis on should the US government want to continue to treat bitcoin as property instead of “real” currency. While the country of El Salvador is adopting bitcoin as legal tender, it is not supplying or distributing any coins to its citizens. The President of El Salvador, Nayib Bukele, has ambitious plans to harness the country’s geothermal volcanic energy to mine bitcoin, but that may fall short of the meaning of issuance as used in the “real” currency definition.
In the context of the “real” currency definition, it is plausible that the US government could require issuance to refer to the sole (or majority) creation and supply of the currency. Bitcoin would certainly fall short of this strict interpretation of the issuance criteria as mining has occurred all over the world since bitcoin’s first block was mined on January 3, 2009.
Alternatively, it is possible the United States government will have a more relaxed interpretation of issuance as it has not been singled out in the government’s guidance issued to date regarding “real” currency. If the government did take a more relaxed approach, it would mean that a bunch of teenagers were issuing real “currency” in 2010 in their parent’s house on their gaming computers. They just did not know they were minting future foreign currency.
Conclusion
We are extremely skeptical the US tax code will adjust based on El Salvador’s decision to adopt bitcoin as the country’s legal tender. Should bitcoin’s adoption as legal tender in El Salvador become ubiquitous in the country and other countries follow El Salvador’s lead, the United States may have to examine the question of whether bitcoin should be classified as “real” currency more thoroughly. If the United States did decide to classify bitcoin as “real” currency, there would be significant consequences under the IRC. The potential tax consequneces of labeling bitcoin as "real" currency is a topic we plan to cover in our next publication. If you have any questions regarding the topics covered in this publication, please contact us.
