Our View on Cryptocurrency Taxes & the IRS
By: Randall P. Andreozzi, Esq.
Cryptocurrency investors be warned. The IRS is coming for you. Over the course of several years, the IRS has methodically ramped up its efforts to tackle the burgeoning cryptocurrency market. As taxpayers enter this market, it’s important that they understand that virtual currency transactions are taxable events involving actual assets and that the IRS treats them as such.
Back in 2014, the IRS issued guidance informing taxpayers and practitioners that it considers virtual currency to be property (rather than currency) for federal tax purposes and that federal tax principles do in fact apply to virtual currency transactions. The wide variety of cryptocurrencies makes them easily convertible. Investors can trade one crypto for another or engage in online purchases, loans, and other transactions with varying forms of crypto, each with its own fair market value at the particular moment of the transaction. This character means that profits and losses on cryptocurrency transactions are taxed like profits and losses on stocks or other capital assets that may appreciate or depreciate in value at capital gains rates. Basis rules apply, which means that investors should be keeping records of their crypto transactions with reference to tax basis of the currency on the particular date of each transaction.
But here, tax rules meet cyber technology in ways that may cause taxpayers and practitioners headaches in maintaining compliance. As just one example, blockchain technology inherently includes such things as “hard forks” that radically change the nature of the currency technology such that the old is outmoded and the new blockchain is the accepted mode. This change could dramatically affect the fair value of the new and the old. The problems that may arise in this area are as varying and unexplored as the technology itself. Thus the IRS cautioned that taxpayers should work with their advisors to track and understand the rules so as to do their best to facilitate proper reporting of such transactions.
In 2017, the IRS won a favorable court opinion holding that the digital currency exchange Coinbase was required to turn over customer information for those who purchased or sold at least $20,000 in cryptocurrency during certain years. This influx of exchange data and the IRS’ increasing effectiveness in the use of data analytics and blockchain technology was a foreshadowing of things to come for taxpayers who may have been noncompliant in their tax reporting of virtual currency transactions.
Last year the IRS established a new Compliance Campaign focusing on cryptocurrency transactions to address tax noncompliance. As with other Campaigns, the IRS promised education, outreach through soft letters and industry initiatives, and ultimately civil examinations and criminal investigations of taxpayers. It followed through on that promise.
In July, the IRS announced that it has begun sending so-called “soft letters” to certain taxpayers involved in cryptocurrency transactions. The purpose of these letters is to educate taxpayers on the Service’s position on cryptocurrency transactions and to establish that those taxpayers have in fact been placed on notice by the IRS. The IRS has announced that, by the end of August, more than 10,000 taxpayers will have received these letters. The IRS has apparently obtained the names of the targeted taxpayers through its compliance Campaign.
Practitioners are now reporting that their clients are receiving these soft letters from the IRS reminding of their reporting requirements on virtual currency transactions and cautioning them of the consequences of failing to come forward on reportable and taxable transactions. Some of the letters received by cryptocurrency investors in recent weeks are more pointed, with the IRS cautioning them that their federal income tax returns might not match information virtual currency exchanges are providing to the IRS. Some letters urge recipients to file amended or delinquent returns. Another version of the letter gives recipients an actual deadline by which to respond in writing and disclose crypto transactions from 2013 through 2017. Each version of the IRS letter has its own Form number – 6173, 6174, or 6174-A. Taxpayers filing returns or amended returns pursuant to one of the letters should identify the letter on the return filed.
This timeline of increased compliance activity makes clear that the IRS is scrutinizing the industry and exchanges, and ramping up its efforts to target non-compliant taxpayers. The gradual change in the communications — from expressing general warnings to suggesting that the IRS possesses records on taxpayers’ cryptocurrency transactions – should be taken as a strong warning to those involved in such transactions that they should immediately consult their tax advisor on the proper tax treatment of the transactions and regarding the possible need to amend returns accordingly. This is particularly important in light of the imminent September 15 and October 15 extended Federal filing deadlines for the 2018 tax year.
The continued and strong warnings issued by the IRS are the same used in other areas wherein the IRS did not hesitate to proceed criminally as well as civilly in the face of more extreme noncompliance. Our experience in such areas, including such Compliance Campaigns as Foreign Bank Account Reporting, Conservation Easements, Welfare Benefit Plans, and the Virgin Islands EDC Program, to name just a few, lead us to believe that the IRS will take no less an aggressive approach here as it has done in those areas, and that it is only a matter of time before the IRS pursues criminal penalties related to unreported or fraudulent cryptocurrency transactions.
The attorneys at Andreozzi Bluestein have extensive experience with civil and criminal tax matters related to these and other Compliance Campaigns. If you or a client have received a notice related to Cryptocurrency transactions and are unsure how to properly respond, please call us at any time for a no-obligation consultation.
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