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 US 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.
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