Cryptocurrency Enforcement is Here by MICHEL STEIN
For those who have failed to report their cryptocurrency transactions correctly — be warned. The Internal Revenue Service (IRS) is paying attention.
IRS Virtual Currency Contact Letters
Beginning this month (July 2019), the IRS has begun sending letters to taxpayers with virtual currency transactions that potentially failed to report income and pay tax from virtual currency transactions or did not report their transactions properly. See IR-2019-132. By the end of August, more than 10,000 taxpayers will receive these letters. For taxpayers receiving these educational or soft letters, there are three variations: Letter 6173, Letter 6174 or Letter 6174-A. According to the IRS, all three versions strive to help taxpayers understand their tax and filing obligations and how to correct past errors. The letters point to appropriate information on IRS.gov, including which forms and schedules to use and where to send them.
The IRS states that the names of these taxpayers were obtained through various ongoing IRS compliance efforts. It is likely that these names were obtained as part of the Coinbase, Inc. (“Coinbase”) Summons Enforcement proceedings, culminating with a District Court Order ordering Coinbase to produce documents on approximately 14,000 of its customers in response to the IRS’ petition to enforce its summons. The court ordered Coinbase, the largest U.S. based virtual currency exchange, to produce accounts with at least the equivalent of $20,000 in any one transaction type (Buy, Sale, Send or Receive) in any one year between 2013 and 2015, and to include: (1) Taxpayers’ identification number; (2) name; (3) birth date; (4) address; (5) record of account activity; and (6) all periodic statements of account.
Undoubtedly, the IRS has culled through this Coinbase information, in additional to information obtained through Third Party Settlement Organization (TPSO) required by the Form 1099-K reporting system, as part of its decision to send these letters. In general, a third party that contracts with a substantial number of unrelated merchants to settle payments between the merchants and their customers is a TPSO. A TPSO is required to report payments made to a merchant on a Form 1099-K, Payment Card and Third Party Network Transactions, if, for the calendar year, both (1) the number of transactions settled for the merchant exceeds 200, and (2) the gross amount of payments made to the merchant exceeds $20,000. When determining whether the transactions are reportable, the value of the virtual currency is the fair market value of the virtual currency in U.S. dollars on the date of payment.
Previously in July 2018, the IRS announced a Virtual Currency Compliance campaign as part of its Large Business and International Compliance Campaign to, among other things, address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS says that it will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations. Virtual currency is an ongoing focus area for IRS Criminal Investigation. The Chief of the Criminal Investigation of the IRS recently announced that he anticipates the public announcement of criminal prosecutions of taxpayers who failed to report cryptocurrency transactions.
Back in 2018, we cautioned that the ordered release of this information is clear warning to all cryptocurrency customers that the IRS has the tools, means and fortitude to seek out and make an example of those who are not in compliance. Today, we see that the IRS is in fact directing its resources to education and on the noncompliant taxpayer. Anyone out of compliance should be thinking long and hard about these issues. Taxpayers should consult with qualified tax counsel regarding the need to utilize the IRS voluntary disclosure practice and the availability of the qualified amended return exception to accuracy related penalties.
IRS Guidance on Virtual Currency
The first and only guidance issued by IRS on the income taxation of virtual currency was IRS Notice 2014-21 (PDF). The IRS Notice describes how existing tax principles apply to transactions using virtual currency in the form of answers to Frequently Asked Questions (“FAQs”). The Notice states that virtual currency is property for federal tax purposes and provides guidance on how general federal tax principles apply to virtual currency transactions. The recent explosion of cryptocurrency has created challenging tax reporting issues with no further guidance from the IRS. Whenever virtual currency is issued, received, spent, bought, sold, traded or given away — there is a potential tax impact. Cryptocurrency is treated as “property” for tax purposes, which typically means gains or losses when disposing of virtual currency—in a realization and recognition event. Anytime virtual currency is used to acquire goods or services, a taxable bartering transaction takes place. Much has changed in the virtual currency world since 2014, and clearly much more guidance is needed. The IRS anticipates issuing additional legal guidance in this area in the near future.
For a detailed discussion of the tax treatment of cryptocurrency, when virtual currency is bought, sold, exchanged for other currency, received through mining or received through a hardfork transaction, see the article Toscher & Stein, Cryptocurrency and IRS Enforcement – Get Ready for Uncle Sam to Look into your Digital Wallet, Journal of Tax Practice an Procedure, Feb.-March 2018.
Voluntary Disclosures for Virtual Currency
Taxpayers who do not properly report the income tax consequences of virtual currency transactions can be liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.
Voluntary disclosure is a long-standing practice of the IRS to provide taxpayers with criminal exposure a means to come into compliance with the law and potentially avoid criminal prosecution. See I.R.M. 184.108.40.206. In November, 2018, the IRS issued memorandum addressing the process for all voluntary disclosures (domestic and offshore). See Memorandum for Division Commissioners, Chief Criminal Investigation, November 28, 2018. The Voluntary Disclosure procedures are designed for taxpayers with exposure to potential criminal liability or substantial civil penalties due to a willful failure to pay all tax due in respect of their noncompliance. The procedures provide taxpayers with exposure potential protection from criminal liability and terms for resolving their civil tax and penalty obligations. Noncompliance with respect to cryptocurrency may be corrected through a timely and complete voluntary disclosure. Different compliance options exist depending upon the facts of each case. Anyone lacking in compliance, should consult a tax professional with experience and expertise with these matters.
For more information about virtual currency tax reporting, the latest on IRS enforcement and potential voluntary disclosure options, we invite you to attend our presentation for Strafford Webinar entitled “Tax Reporting of Cryptocurrency Calculating Basis, Income and Gain” scheduled for Thursday, August 29, 2019, 1:00 p.m. – 2:50 p.m. EDT/ 10:00 a.m. – 11:50 a.m. PST.