Tax News: Political and Economic Unrest in Venezuela is Felt on U.S. Tax Returns

 In Tax News

Venezuela is in the midst of a very turbulent time.  There have been deadly protests, and many people feel the government may be in jeopardy.  The unrest has further complicated an already complex economic situation.  According to Oanda.com and the IRS reference table the current exchange rate is roughly 6.3 Venezuelan Bolivars to 1 U.S. Dollar.  However, ask any Venezuelan or recent traveler to Venezuela on Tripadvisor and they will tell you that you cannot walk into the bank in Caracas and exchange Bolivars for Dollars, let alone at a rate of 6.3:1.  As such, Venezuelans have taken to the black market in order to exchange Bolivars for Dollars.  This is not your average black market.  It is very established and because of the bank situation it may be more appropriate to label it the de facto market instead of black market – because black market seems to hint that there is a different legitimate option, which there is not in this case.  The black market even has an unofficial website (dolartoday.com), which tracks the rate people are exchanging Bolivars for other currencies.  Per this website, and numerous other reports, the actual exchange rate for Bolivars to Dollars is actually roughly 80:1.

How does this affect Americans?  U.S. citizens and residents have to pay taxes on worldwide income.  Therefore, any earnings from Venezuela would have to be reported on a U.S. tax return.  But at what rate?  Generally, the rate of translation is taken from Oanda, the IRS website, or another reputable source.  Since there is generally little variation it often isn’t an issue exactly what source is used.  In the case of Venezuela it can have disastrous consequences.  For example, if a taxpayer earning 500,000 Bolivars were to use the Oanda or IRS rate they would have to report earnings of roughly $79,000.  Nevertheless, because of the current situation they could not actually exchange this 500,000 Bolivars for $79,000.  Instead, they would be forced into the black market where the 500,000 Bolivars would gain them roughly $6,000.  Therefore, the U.S. taxpayer would have only $6,000 in their pocket but would have to pay tax on $79,000 of earnings.  This means a U.S. taxpayer with Venezuelan income likely would not even have enough earnings to pay the tax that he owed on those earnings.

This situation is leaving U.S. taxpayers to ask what is the correct rate to use on a tax return?  According to IRS.gov,

“The Internal Revenue Service has no official exchange rate. Generally, it accepts any posted exchange rate that is used consistently.  If you have a single transaction, such as the sale of a business that occurred on a single day, use the exchange rate for that day. However, if you receive income evenly throughout the tax year, you may translate the foreign currency to U.S. dollars using the yearly average currency exchange rate for the tax year.  If there is more than one exchange rate, use the one that applies to the facts and circumstances on a consistent basis.”

Applying this to the facts at hand, it would appear the IRS would accept the unofficial rate if it is the actual rate people are exchanging money.  However, as you can imagine, using a rate other than what is posted on the IRS website makes many taxpayers uncomfortable.  Rightfully so, because in the event of an audit it would be the taxpayer’s responsibility to show the IRS the rate they used is more accurate than the IRS rate, which is not a challenge that should be taken lightly.

Overall, there is no easy answer.  Even though the IRS does not say you have to use its rate, it does not mean taxpayers can pick any unofficial rate.  Likewise, using the IRS rate could cause problems itself.  There are many factors that can go into how to handle a decision such as this.  It is key to have extensive, proper documentation and also to make sure the actual finances of the situation match what is reported on the tax return.  If you have questions regarding exchange rates or foreign income, contact us at Hone Maxwell LLP today for a complete analysis of your situation.  Also,  you can follow us on twitter @HMLLPTax or facebook at www.facebook.com/HoneMaxwellLLP for more tax tips and the latest updates on tax news.

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