Crypto-currency / Bitcoin – Is this the 21^st century answer to hiding assets in Swiss bank accounts? 

The IRS thinks this is the case which is why the IRS has stepped up its investigation efforts to uncover non-compliant taxpayers just like the IRS successfully did in its investigation of the Swiss banks leading Congress to enact the Foreign Account Tax Compliance Act (“FATCA”).  FATCA forces foreign banks to disclose information on U.S. account holders which the IRS receives and matches the information reported by U.S. taxpayers.  No longer can taxpayers avoid reporting income on their foreign bank accounts.  No longer can taxpayers avoid disclosing their foreign bank accounts.

But with Bitcoin and other crypto-currencies, there is no such third party reporting.  Digital exchanges are not broker-regulated by the IRS. Exchanges do not issue a 1099 form, nor do they calculate gains or cost basis for the trader.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Crypto-currency Transactions.

A John Doe Summons issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase will be required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

ON MARCH 16, 2018 COINBASE COMPLIED WITH THIS SUMMONS AND TURNED OVER DATA OF 14,355 ACCOUNT HOLDERS TO IRS.

Now while this net may not pick up taxpayers whose accounts have less than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year from 2013 to 2015, it should be clear that this is the first step for the IRS to crush non-compliance for all taxpayers involved with cryptocurrency just like the IRS was successful in battling taxpayers having undisclosed foreign bank accounts.

10,000 Crypto-currency Owners Receiving Warning Letters From The IRS

After years of analyzing data from third parties involved in the cryptocurrency exchanges, the IRS announced in a press release on July 26, 2019 that it has started sending letters to cryptocurrency owners advising them to report their cryptocurrency transactions and pay their taxes. More than 10,000 taxpayers have been identified by IRS as being involved in cryptocurrency transactions but who the IRS believes may not have been compliant in reporting these transactions on their tax returns.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

Notices Being Sent To Taxpayers Are The First Step In IRS Enforcement Action

The IRS is using three types of notices to send to more than 10,000 taxpayers by the end of August 2019 – notices 6173, 6174 or 6174-A. All three notices indicate the IRS has information that the taxpayer receiving the notice currently has or has had virtual currency. However, it is Letter 6173 that is most serious as it requires a signature from the recipient under perjury that they are compliant with the U.S. tax code or requiring taxpayers to respond to the IRS and either file delinquent returns for tax years 2013 through 2017 or amend previously filed returns and include the applicable forms or schedules reporting cryptocurrency transactions. If you receive a Letter 6173, it should be a virtual certainty that you will be selected for examination.

If you receive Letter 6173, you should consult with a tax attorney as the submission of a statement signed under penalties of perjury that is false can result in serious consequences including criminal prosecution.

Virtual Currency Is An Ongoing Focus Area For IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

The Proposed 2019 Form 1040 Makes It Harder For U.S. Taxpayers To Avoid Non-compliance Or Claim Ignorance.

The IRS has now issued the second early release draft of the 2019 Form 1040, Schedule1, Additional Income and Adjustments to Income, which includes the following checkbox question:

At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?   ◊ Yes            ◊ No

Taxpayers who file Schedule 1 to report income or adjustments to income that can’t be entered directly on Form 1040 will now be required to check the appropriate box to answer the virtual currency question. Taxpayers do not need to file Schedule 1 if their answer to this question is NO and they do not have to file Schedule 1 for any other purpose. This requirement is similar to how the IRS includes questions on Schedule B inquiring whether a taxpayer has foreign bank accounts.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

Taxation Of Crypto-currency

Since 2014 the only guidance issued by IRS on the taxation and reporting of crypto currency was Notice 2014-21. Expanding on this guidance, the IRS issued additional detailed guidance to help taxpayers better understand their reporting obligations for specific transactions involving virtual currency. The new guidance includes Revenue Ruling 2019-24 and frequently asked questions (FAQs).

Although both the public and the crypto community refer to bitcoin, altcoin, etc. as “virtual currencies”, the IRS in 2014 issued Notice 2014-21 stating that it treats them as property for tax purposes. Therefore, selling, spending and even exchanging crypto for other tokens all likely have capital gain implications. Likewise, receiving it as compensation or by other means will be ordinary income.

Some would think that if bitcoin is property, trades should be tax deferred under the like-kind changes rues of IRC Sec. 1031.  Under that theory someone who owned Bitcoin could diversify their holdings into Ethereum or Litecoin, and plausibly tell the IRS it created no tax obligations. Unfortunately, the new Tax Cuts & Jobs Act of 2017 does away with that loophole making it clear that “like kind exchanges” which lets people swap an asset for a similar one without triggering a tax obligation are not available for non-real estate assets.

While bitcoin receives most of the attention these days, it is only one of hundreds of cryptocurrencies. Everything discussed with regard to bitcoin taxation applies to all cryptocurrencies.

Here are the basic tax rules followed by IRS on specific crypto currency transactions:

• Trading crypto currencies produces capital gains or losses, with the latter being able to offset gains and reduce tax.
• Exchanging one crypto currency for another — for example, using Ethereum to purchase an altcoin — creates a taxable event. The token is treated as being sold, thus generating capital gains or losses.
• Receiving payments in crypto currency in exchange for products or services or as salary is treated as ordinary income at the fair market value of the coin at the time of receipt.
• Spending crypto currency is a tax event and may generate capital gains or losses, which can be short-term or long-term. For example, say you bought one coin for $500. If that coin was then worth $700 and you bought a $700 gift card, there is a $200 taxable gain. Depending on the holding period, it could be a short- or long-term capital gain subject to different rates.
• Converting a crypto currency to U.S. dollars or another currency at a gain is a taxable event, as it is treated as being sold, thus generating capital gains.
• Air drops are considered ordinary income on the day of the air drop. That value will become the basis of the coin. When it’s sold, exchanged, etc., there will be a capital gain.
• Mining crypto currency is considered ordinary income equal to the fair market value of the coin the day it was successfully mined.
• Initial coin offerings including certain forks do not fall under the IRS’s tax-free treatment for raising capital. Thus, they produce ordinary income to individuals and businesses alike provided that the taxpayer receives units of new cryptocurrency.

Given the limited guidance by IRS, there are still tax positions that can be advocated or structured so that taxpayers dealing with crypto currency can defer gains and minimize taxes. That is why it is essential you seek qualified tax counsel.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS! And this is why the IRS is first sending Letter 6173 requiring a signature from the recipient under perjury that the taxpayer is compliant with the U.S. tax code BEFORE the IRS then decides to audit the taxpayer.

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

With only several hundred people reporting their crypto gains each year since bitcoin’s launch, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.  And now that like-exchange treatment is prohibited on transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.