What cryptos can expect from a Title 31 exams

February 3, 2020
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Can cryptocurrency businesses be subjected to IRS Title 31 exams? In short, yes. The IRS uses Title 31 to prevent money laundering, meaning more and more cryptocurrency businesses could face the examination.

When you were in school, you probably hated tests — especially those pop quizzes you were never prepared for. Unfortunately, those days aren’t completely behind us just yet, especially those of us in the crypto space.

As regulators increasingly turn their eye to cryptocurrency businesses in late 2020 and beyond, entrepreneurs in the industry must increasingly prepare for the possibility they will be selected for a Title 31 Examination by the IRS.

Is this an audit? Yes, but not of your taxes. Instead, it’s about ensuring that you meet the Title 31 Anti-Money Laundering (AML) requirements.

Here’s what you can expect from a Title 31 examination, and how you should prepare for the possibility of being selected.

What is a Title 31 examination?

Title 31 exams - BitAML blogTitle 31 was initially aimed at casinos and other traditional non-bank financial institutions (NBFIs) to prevent money laundering. Now, money laundering concerns have extended to cryptocurrency businesses. As a result, the IRS has begun to do examinations on them as well.

Many large exchanges have already faced such exams, but just like in the casino example, these exams are not limited to the largest businesses or business models. In fact, several crypto exchangers, both big and small, are facing these exams. This includes cryptocurrency kiosk/ATM operators, online exchangers, and P2P traders.

Point being, small money transmitters must also be prepared.

But how? What are regulators looking for?

Simply put, they want to see that you have a robust AML compliance program in place. This means tough, up-to-date policies and procedures that fulfill all five pillars of the Bank Secrecy Act and a culture of compliance that is incentivized and reinforced every day.

It is our understanding that the IRS doesn’t have a formal selection process, and will select businesses for Title 31 at random and without any warning.

You will just receive a notice that the IRS is coming in person to ensure that your money services business enforces crypto AML that complies with the BSA. They’ll generally review a six-month range of transactions.

If they find that you do not meet the standards of Title 31 compliance, your business could be subject to penalties.

What preparing for Title 31 exams look like

Cryptocurrency AML compliance program

You’ll need to ensure that your crypto AML program is strong and meets all federal and state requirements. Among other things, you need to have appointed a BSA Compliance Officer, ensure your business is registered as an MSB/money transmitter with FinCEN, and have a compliance program in place.

Your program should include policies that cover Know Your Customer/Customer Due Diligence (KYC/CDD) processes, an OFAC screening procedure, customer identification and Enhanced Due Diligence (EDD), a SAR policy, CTR policy, guidelines on records retention, and more. You also need an independent testing process and a compliance training routine for your staff.

Overall, the IRS and FinCEN want to ensure that all federal and state AML requirements are followed. Crypto attorney Sasha Hodder rightly points out in this Medium post that what’s in practice is more important than what’s on paper.

Paperwork required

In Hodder’s article, you’ll find a list of 71 documents that need to be submitted before or during the on-site examination. This list will also be included in the Title 31 Examination notice you receive.

These range from information about the BSA Compliance Officer to copies of AML risk assessments to copies of the most recent independent AML review. You’ll want to review the list carefully to ensure you’re fully prepared before the IRS examiners arrive.

The Funds Travel rule

One of the biggest concerns that cryptocurrency businesses have about compliance is the Funds Travel Rule. This rule is difficult for crypto companies to follow, as it’s really intended for a traditional financial institution.

It’s completely sensible to be worried about failing this portion of the Title 31 test, since it isn’t clear how a crypto company can set up the appropriate processes. We’ve heard from some exchanges going through exams that a few key themes keep coming up.

It should be stressed to the ends of the earth that this doesn’t constitute comprehensive or legal advice, but regulators seem to be most focused on three things:

  • They want to make sure your business understands the Travel Rule
  • They want to know what measures you have taken so far to be compliant with it.
  • They want to know what vendors you have spoken with and if you know who can help you with travel rule compliance.

What are the penalties for Title 31 cryptocurrency errors?

The IRS wants to ensure your AML compliance program is risk-based and tailored to the unique needs, risk profile, and structure of each institution.

Of course, that’s a bit vague. The Title 31 FAQ offered by the IRS answers some specific questions, but most people who have been through these exams will tell you the results are quite subjective.

The fines assessed by FinCEN for compliance mistakes are not set by a strict matrix. Instead, the regulators weigh a number of factors. These include the nature of the violations, how serious they are, and what knowledge, if any, you had that violation(s) were taking place.

They’ll look at your intent and what remedial measures are in place. Additionally, regulators have historically taken into account the level of cooperation they receive throughout the examination process.

Finally, they’ll review the financial condition of those involved and see what payments and penalties you’re already under from other enforcement actions, if any.

Key takeaways for cryptocurrency businesses

The cryptocurrency space has several tests — just like those annoying pop quizzes in school — coming in the next couple years. But the good news is, these are tests you can start preparing for.

Title 31 Exams are not only for select cryptocurrency businesses. Instead, we’re seeing notices issued en masse and expect this trend to continue. The compliance guidelines apply to all money services businesses, whether large or small, traditional or crypto.

The best thing you can do to increase your chance of passing the Title 31 test is to work with a professional who can help you navigate the crypto AML requirements. This is especially important for sticky issues like the Funds Travel Rule.

Remember, one of the major things the IRS wants to see is that you know where to get information and assistance meeting regulations.

If you want to set up a review of your AML compliance program to ensure it’s strong enough for a Title 31 Exam, we can help. Contact us today.

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