In the latest step by the IRS to address taxation issues in the digital on-line economy, the IRS has filed its first enforcement against convertible virtual currency, targeting tax abuse of “Bitcoin” transactions. On November 20, 2016, a Federal Court in California authorized the IRS to issue a “John Doe” summons to Coinbase, Inc., a web-based global digital currency wallet and platform. The IRS has in the past successfully used the John Doe summons to obtain information from financial institutions (e.g., UBS, HSBC and Cayman Islands banks) for a broad class of U.S. clients who are not individually named but who the IRS has reason to believe have utilized the financial institution to improperly evade tax. The John Doe summons seeks records from 2013 through 2015 for any Coinbase user with a US address, telephone number, e-mail domain, etc., and all records related to disbursement of funds to any user. In 2014, the IRS issued Notice 2014-21 describing how various income recognition and other US tax principles apply to virtual currency transactions. In that Notice, the IRS clarified that virtual currencies are “property” subject to income tax, capital gains tax, etc.
Omission of income from virtual currency transactions or failure to file, especially in relation to offshore transactions or use of foreign accounts, could result in criminal charges related to tax evasion, filing a false tax return and failure to file the FBAR (FinCen Form 114). Additional charges can include conspiracy to defraud the government. Even innocent or negligent non-compliance can subject a taxpayer to the assessment of tax, interest and severe civil penalties. Taxpayers have a limited time period remaining to voluntarily disclose virtual currency accounts and transactions, to correct prior non-compliance, avoid criminal prosecution and usually receive more lenient treatment than in a criminal or civil enforcement proceeding or audit.
Once the IRS obtains information on Coinbase’s users, the IRS will follow with civil tax audits, FBAR audits and criminal investigations. Other virtual currency platforms, such as Localbitcoins, Kraken and ItBit may receive similar summonses for transactions with Bitcoins and its more recent competitor Ethereum. The IRS offers opportunities to come into compliance before the IRS obtains information about unreported assets (virtual or actual) and income, including the Offshore Voluntary Disclosure Program (OVDP) and Streamlined Filing Compliance Procedures for taxpayers to disclose digital currency transactions, income and accounts. A voluntary disclosure also provides the opportunity to calculate, with a reasonable degree of certainty, the total cost of resolving open tax issues. Time is of the essence to voluntarily report such information before the IRS obtains information pursuant to John Doe summonses, FATCA (the Foreign Account Tax Compliance Act), TIE (Tax Information Exchange) Agreements, etc. Anyone who has income as a result of transactions through Coinbase, Inc. or any other virtual or digital platforms, or unreported virtual or digital currency assets, should contact Rubinstein & Rubinstein, LLP immediately for a consultation.