New IRS Voluntary Disclosure Application Gets More Virtual by: JONATHAN KALINSKI and PHILIPP BEHRENDT
This week, the IRS updated the Voluntary Disclosure Practice Preclearance Request and Application, Form 14457. Most notably, it includes a new section on disclosing virtual currency information.
When it comes to the new information that has to be disclosed, two points stand out. The first is that you must disclose all aliases and citizenship. Although the prior version of the form required you to list all passport information, which would imply citizenship, the new version goes a step further.
The IRS is likely requiring this information for a few reasons. One, the IRS might be able to cooperate and gain information from the country of which the taxpayer is a citizen. It could also supply information to that country. Those coming forward should make sure they are tax compliant in other countries. This information could also increase collection of future liabilities. The IRS has made an emphasis recently that it will pursue collection even if an individual’s assets are overseas.
For years now the IRS has focused on virtual currency enforcement and this is the latest step. The previous form required you to list if the disclosure was related to virtual currency, but only required you to list financial accounts as part of the preclearance. This arguably did not include virtual currency wallets and the like.
Virtual currencies now must be disclosed in Part 1, Line 13. This includes not only transactions of virtual currencies during the disclosure period but also assets owned or controlled directly or indirectly. The disclosure also requires the inclusion of the location where the virtual currency has been held.
This section still raises several questions including whether NFTs need to be disclosed. The use of the word virtual currency may suggest a limited disclosure requirement for assets with some form of fungibility. And while the case can be made that IRS experts are aware of the distinction between fungible and non-fungible assets, the instructions make it clear that the IRS is looking for a full and complete disclosure. The instructions acknowledge that virtual currency is a dynamic area and that, for the purposes of this form, the term “encompasses assets beyond what many define as virtual currencies.” The reference to the IRS FAQ on virtual currency transactions shows that the IRS has a rather broad understanding and describes virtual currency as “a digital representation of value, other than a representation of the U.S. dollar or a foreign currency (‘real currency’), that functions as a unit of account, a store of value, and a medium of exchange.” When in doubt, disclose.
Note also that the form requires you to disclose “noncompliant” assets. For virtual currency, that is any asset that should have been reported on a federal income tax return or other required federal information return that was not previously disclosed. Simply holding virtual currency does not require you to disclose the asset on a return. The noncompliance comes from not reporting a taxable transaction.
The Preclearance request is not the time not to make a full and fair disclosure. The purpose of a voluntary disclosure is to come into tax compliance and eliminate criminal exposure and reduce civil penalties, not to use technicalities to not disclose assets. The preclearance request is only the first step in a long process. Any further non-compliance bears the risk of rejection (and a possible criminal investigation) right at the start and must be avoided. Questions of whether a transaction is or is not taxable can be resolved down the road, but not at this point.
The new form also requests information on the use of mixers and tumblers, including identification of the one used and an explanation of why it was used. Mixers and tumblers are services offering to mix crypto currency streams of different users to blur the otherwise traceable origin and thereby enhance the privacy; a service that can easily be abused to obscure the source of tainted funds. This reflects the IRS continued use of all programs to expand data collection and analysis. The IRS can use this information to identify new mixers and tumblers for potential further investigations or a potential John Doe summons by receiving information directly from former customers. The question also shines a light on the taxpayer’s transactions to identify potentially illicit funds or assets. If the taxpayer’s source of income is of an illicit nature, the taxpayer would not qualify for a voluntary disclosure.
To become compliant through the IRS voluntary disclosure program, the taxpayer is therefore well advised to seek professional assistance from someone who is both familiar with the intricacies of the voluntary disclosure practice and who understands virtual assets.
Jonathan Kalinski is a principal at Hochman Salkin Toscher Perez, P.C. and specializes in both civil and criminal tax controversies as well as sensitive tax matters including disclosures of previously undeclared interests in foreign financial accounts and assets and provides tax advice to taxpayers and their advisors throughout the world. He handles both Federal and state tax matters involving individuals, corporations, partnerships, limited liability companies, and trusts and estates.
Mr. Kalinski has considerable experience handling complex civil tax examinations, administrative appeals, and tax collection matters. Recently, he has focused on the taxation of cannabis and cryptocurrency. Prior to joining the firm, he served as a trial attorney with the IRS Office of Chief Counsel litigating Tax Court cases and advising Revenue Agents and Revenue Officers on a variety of complex tax matters. Jonathan Kalinski also previously served as an Attorney-Adviser to the Honorable Juan F. Vasquez of the United States Tax Court.
Philipp Behrendt is an Associate at Hochman Salkin Toscher Perez P.C., and a graduate of University of Southern California (USC) Gould School of Law (LL.M.) and a former associate of the leading German tax firm. Philipp’s prior experience includes representing wealthy individuals and companies in global tax settings, cross-border investigations and audit matters, as well as handling complex voluntary disclosure issues for U.S. and other international companies, stemming from tax avoidance structures as well as crypto assets..