The IRS and Cryptocurrency Transactions
Both digital currencies and cryptocurrencies have been around for several years (Bitcoin since 2009), but only in the past couple of years has the IRS begun to really focus its enforcement on cryptocurrency transactions. So far the IRS approach has been focused on Enforcement and Punishment, rather than amnesty and voluntary prior year disclosure, a “Stick” approach (punishment) without the “Carrot” (reward). The current IRS approach presents both taxpayer risk and opportunity.
In 2014 the IRS issued Notice 2014-21 that rules virtual currencies (Cryptocurrency Transactions) are to be taxed as property. This establishes a reporting requirement for cryptocurrency gains (digital currencies) to be reported and taxed.
A single data point summarizes current IRS concern over Cryptocurrency: In 2016, out of 132 million electronically filed income tax returns, only about 800 reported any income from cryptocurrency activity. That is 0.0006%, which rounds nicely to zero-percent (0%).
The IRS is addressing their concern on several fronts:
- Following a lengthy period of litigation against Coinbase (2017), a company that facilitates digital currencies like Bitcoin and Ethereum, the IRS successfully obtained the names of about 13,000 Coinbase customers who had engaged in virtual currency transactions.
- The IRS Criminal Investigation Division is focusing on scrutinizing Cryptocurrency transactions by assembling a specialized team of investigators.
- Earlier this year during the tax-filing season, the IRS issued a public reminder that taxpayers are required to report all Cryptocurrency transactions. The IRS then threatened to audit and assess financial penalties and even criminal prosecution for non-compliance.
- In July 2018 the IRS Large Business and International Division (LB & I) announced a compliance campaign, which includes virtual currencies and crypto. Last year the LB & I announced a movement to a risk-based approach to tax audits and has announced several areas, including Cryptocurrency that will be the focus of its future examination strategy.
- U.S. persons are subject to tax on their worldwide income from all sources, including virtual currency.
- Taxpayers should correct their previously filed income tax returns to report crypto transactions as property.
- The IRS campaign will include taxpayer outreach and examinations.
- The IRS is not contemplating a voluntary disclosure program to address noncompliance.
- Therefore the responsibility is placed entirely on the taxpayer to understand the law.
- The IRS identifies a behavior they are concerned with, e.g., failure to report Cryptocurrency transactions.
- The IRS develops a program of published “reminders”, the intent of which is to “educate” taxpayers about the issue and stop the behavior.
- Curbing the behavior is achieved through targeted audits and/or letters to specific taxpayers requiring additional information.
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In summary, the IRS described its newly announced focus on virtual currency compliance as follows:
The IRS cyber currency (virtual currency) compliance program is just what it sounds like, a program to get taxpayers to comply with IRS interpretation of existing laws. Based upon other IRS programs we feel it will go like this:
The taxation of Virtual currencies and crypto are still in their early stages. Other than IRS Notice 2014-21, very little IRS guidance has been provided to taxpayers. Cryptocurrency issuance matters, including ICOs, coin for services and crypto bartering, as well as the tax issues for hard forks (e.g., Bitcoin Cash) or Cryptocurrency-to-Cryptocurrency trades, have not been addressed.
Because virtual currencies may be held anywhere in the world, Cryptocurrency owners are also subject to foreign reporting requirements of FinCIN (Financial Crimes Enforcement Network). Penalties beginning at $10,000 per account apply for noncompliance.
Morris + D’Angelo has successfully helped many taxpayers navigate the current environment of high uncertainty and risk, with increasing IRS enforcement. We are also very involved in a number of leading virtual currency and blockchain thought-leader organizations, including the Accounting Blockchain Coalition.
Because the IRS believes that Cryptocurrency is property, we see the opportunity to classify certain crypto-sales as long-term capital gains, thus subject to preferential federal income tax rates.
We also believe that the IRS will eventually move to a carrot and stick compliance model by allowing a voluntary disclosure program that allows taxpayers to report prior year Crypto Currency transactions without the current threat of financial penalties and or legal prosecution. This model has been employed in a variety of other areas, including the reporting of foreign assets and we think this approach is warranted here.
Joseph frequently provides Media Content via Workshops, Podcasts and Printed Articles on topics like Bitcoin and Cryptocurrency, Wealth Preservation and Planning, Global Banking and many other high-level financial topics that serve and demonstrate the Value of our Global Network that should be of interest to those who need Private High-Wealth Services.
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Joseph McCaffrey a Partner of Morris + D’Angelo, a multi-office, boutique tax, accountancy and advisory firm heads the San Francisco office.
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