The Internal Revenue Service (IRS) made a pair of announcements on July 2 that it is increasing its focus on taxpayers who avoid their tax obligations using cryptocurrency.
By way of background, in April 2014, the IRS issued Notice 2014-21, which generally provided that “convertible virtual currency” is treated as property, not currency, for tax purposes and explained, in question and answer format, the application of existing general tax principles to transactions using convertible virtual currency. The Notice defines virtual currency as “a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” It further provides that convertible virtual currency is “[v]irtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency,” citing bitcoin as one example of a convertible virtual currency.
The Notice describes some of the tax consequences of receiving or exchanging virtual currency for property or services. If a taxpayer receives virtual currency in payment for goods or services, he or she has taxable income equal to the fair market value of the virtual currency. If the taxpayer uses virtual currency to acquire goods or services, and the fair market value of property received in exchange for virtual currency exceeds the taxpayer’s adjusted basis of the virtual currency, then the taxpayer has taxable gain.
The IRS became concerned that taxpayers were not reporting cryptocurrency transactions, and in November 2016, sought a court order to serve a John Doe summons on Coinbase, one of the world’s largest digital asset exchange companies. The summons sought broad information on all U.S. customers conducting transactions in cryptocurrency from 2013-2015. Although the court ultimately narrowed the scope of information that the summons could request, it did order Coinbase to comply with the summons. Click here to read Steptoe’s blog post about the Coinbase summons.
New IRS Announcements
On July 2, the IRS Large Business and International division (LB&I) announced a new audit campaign to address tax noncompliance related to the use of virtual currency. LB&I campaigns direct the IRS’s audit resources to specific areas the IRS believes have the greatest risk of noncompliance. Virtual currency is one of 40 campaigns that have been announced by the IRS since January 2017. The IRS’s announcement means that taxpayers who failed to report virtual currency transactions face an increased risk for audit.
The IRS stated that it does not plan to start a voluntary disclosure program specifically for virtual currency like it had in the past for foreign bank account reporting. But the IRS has a general procedure in place for voluntary disclosure. Voluntary disclosure does not guarantee that a taxpayer will not be prosecuted, but may result in the government not recommending prosecution. In order to be considered a voluntary disclosure, the taxpayer must (i) engage in a truthful, timely, and complete communication with the IRS, (ii) show a willingness to cooperate with the IRS to determine his correct tax liability, and (iii) make arrangements with the IRS to pay in full the tax, interest, and any penalties determined by the IRS to be applicable. The disclosure must occur before the IRS has initiated a civil or criminal investigation of the taxpayer or notified the taxpayer of its intent to do so. The IRS’s Internal Revenue Manual sets forth in more detail the requirements for voluntary disclosure.
If a taxpayer has failed to report foreign financial assets, the taxpayer may also be able to take advantage of the IRS’s Streamlined Domestic Offshore Procedures. The streamlined procedures are available to taxpayers whose failure to pay tax did not result from their own willful conduct. Streamlined procedures include procedures for filing amended or delinquent and terms for resolving taxpayers’ tax and penalty obligations. Like voluntary disclosure, a taxpayer cannot participate in the streamlined procedures if the IRS has already initiated a civil or criminal investigation of the taxpayer or notified the taxpayer of its intent to do so.
Click here to read the LB&I announcement in full.
Also on July 2, the IRS announced a joint international coalition to investigate cryptocurrency related tax crimes and money laundering. The Joint Chiefs of Global Tax Enforcement (known as the J5) includes agencies from Australia, Canada, the Netherlands, and the United Kingdom in addition to the IRS. The J5 will work together to gather information, share intelligence, conduct operations, and build the capacity of tax crime enforcement officials. Click here to read about the J5.
This follows an announcement by Don Fort, chief of the IRS Criminal Investigation (“CI”) Division that they are requiring mandatory cyber training for all CI employees.
In its announcement of the virtual currency compliance campaign, the IRS said that it continues to work on guidance, but unfortunately the pace of guidance to taxpayers on how to report and comply with the law relating to cryptocurrency hasn’t kept up with the pace of IRS enforcement. What is clear is that the IRS is stepping up its civil and criminal enforcement of cryptocurrency transactions. If you have unreported transactions or are contacted by the IRS, it is recommended that you consult with a tax advisor to discuss your options.