El Salvador adopts bitcoin as its legal tender is much bigger news than most realize

Visionary, young, energetic and tech-savvy president of El Salvador, Nayib Bukele, announced on June 5th, 2021 during the biggest Bitcoin Conference 2021 in Miami via a video presentation that he will send to Congress a bill that will make bitcoin a legal tender in El Salvador.

Nayib Bukele believes that crypto allows protection from dangerous central bank actions and to mitigate the negative impact from central banks, it becomes necessary to authorize the circulation of a digital currency in a manner that the central bank should not have control over its supply.

The responsibility of creating the plan for this bill is given to Jack Mallers, CEO of bitcoin investment and payments company Zap. He also believes that Bitcoin is a solution to many of their problems and In the short term, this will generate jobs and help provide financial inclusion to thousands in the country.

Jack Mallers had spent some time in El Salvador and discovered that nearly 70% of the population in the country does not have a bank account, and a majority of the country’s GDP (nearly 20%) comes from remittances sent by migrants to family members. Strike, the payment product of Zap was launched in El Salvador in March 2021, and it has been “onboarding” 20,000 El Salvadorans per day. Jack Mallers framed Bukele’s forthcoming legislation as the next step in a partnership between Strike, which will open an office in El Salvador, and the local government there.

El Salvador is one of those non-U.S. nations that uses the U.S. dollar as its official currency. El Salvador’s recent shakeup of its justice system has created tensions between the Central American nation and the United States. In May 2021, the U.S. Agency for International Development (USAID) said it will redirect funding away from El Salvador’s state institutions (including its Attorney General’s office) and give it instead to local human rights organizations.

If the legislation passes in El Salvador, it will become the first nation with Bitcoin as legal tender. However, from the tax and accounting perspective, many rules need to be adjusted to acknowledge that bitcoin is or can be the currency in some instances because it can not be just treated as a capital asset.

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US tax and reporting implications if El Salvador makes Bitcoin legal tender

It’s no doubt a piece of great news for Bitcoin and the crypto world as well for El Salvador, however, there are nuances in the internal revenue code that make this news much bigger than most of us realize as pointed out by a Reddit user.

Everyone knows that trading foreign currencies gains must be reported and are taxed but as per section 988(e), there is an exception called ‘de minimis‘ for “personal transactions” where the gains do not exceed $200. The reason for this exception was to allow travelers to transact in foreign currencies without all of the burdensome reporting requirements.

Bitcoin, so far wasn’t able to leverage this exception been categorized as “property” and not a “currency” because “it does not have legal tender status in any jurisdiction” as per IRS Notice 2014-21. There is a good argument, though, that once Bitcoin is “legal tender” in El Salvador, it will qualify for US individuals as a “non-functional currency” (under Section 988), allowing individuals to forgo reporting gains on small, daily transactions—“personal transactions.”

In other words, if Bitcoin is legal tender in El Salvador, US citizens could possibly freely transact in Bitcoin, as a “nonfunctional currency,” without a need to report gains of less than $200.

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It is not just the US retail citizen that will benefit from it, but there is something great for the US bitcoin business as well.

Most US businesses use the US dollar as their unit of account for bookkeeping and reporting. However, there are cases where businesses operating primarily in foreign jurisdictions use a foreign currency—the unit of account does not have to be USD. The unit of account used by the business is the “functional currency” of the business and, perhaps, even an individual (see Sec. 985 IRC). If a business’s “functional currency” is a foreign currency, it does not have to bother with gains/losses related to USD fluctuations.

So far, as per IRS Notice 2014-21, Bitcoin cannot qualify as a functional currency before but now this could change if El Salvador adopts Bitcoin as legal tender. If Bitcoin becomes legal tender in El Salvador, IRS Notice 2014-21 may become partially null, relieving US individuals and businesses of huge tax and reporting burdens, paving the way for Bitcoin to legally and easily be used as a currency in the US.