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Asset Protection Blog

IRS Continues to Target Crypto Assets: Are You Compliant?

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By Asher Rubinstein and Adam J. Berkey

In early March, the Internal Revenue Service (IRS) announced “Operation Hidden Treasure,” a new fraud enforcement initiative focused on detecting unreported crypto-related income. 

The Operation, announced at a Federal Bar Association virtual tax conference, is a joint effort between the IRS Criminal Investigation (CI) Division and the newly created IRS Office of Civil Fraud Enforcement. 

At the Bar Association conference, the IRS revealed that a dedicated team of agents has been trained to identify the digital “signatures” of crypto-related tax evasion — e.g. “structuring” a higher-value transaction as several sub-$10,000 transactions to avoid reporting obligations, and using anonymized ownership vehicles (a/k/a “shell” corporations) — and in methods of attributing seemingly unrelated transactions (whether effectuated on-chain or even “off-chain”) to a common U.S. taxpayer.

Failing to report crypto-source income completely and accurately may result in criminal tax charges and jail time and/or civil penalties of up to seventy-five percent (75%) of the understated tax liability.  If digital assets are held in offshore entities, additional charges may apply.

We have been advising on tax compliance for digital assets for many years.  Please see our articles here. For questions or concerns about crypto-related tax compliance, please contact our tax and asset protection attorneys at Gallet Dreyer & Berkey, LLP.  We remain at the forefront of tax-planning and wealth-preservation strategies incorporating digital assets.  

IRS Targets Bitcoin and Other Virtual Currencies: Are You Tax Compliant?

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Over the past few years, the IRS has focused on whether taxpayers are properly reporting income from transactions involving virtual currencies including Bitcoin.  See our previous articles: “IRS Advances Against Bitcoin Tax Evasion”, “Bitcoin Surges in Value Again: Tax Consequences”, and “Now Is The Time To Confirm Your Bitcoin Is Tax Compliant.”  Recently, the IRS issued IR-2019-132, which announced the IRS’s next step: sending letters to taxpayers who may have failed to properly report income from virtual currency transactions.  These letters further demonstrate that the IRS will enforce the tax laws applicable to virtual currencies.  Compliance with these laws is necessary to avoid penalties.

There are three types of letters sent to taxpayers, differing based on the degree of potential violation: Letter 6173, Letter 6174, and Letter 6174-A.  While the IRS stated that these letters are “educational letters” to inform taxpayers of their responsibilities to report virtual currency transactions, penalties might still apply.  The letters range from a “soft notice” to a warning letter for those whom the IRS suspects of more serious violations. 

These letters demonstrate the IRS’s focus on digital currencies, and whether taxpayers are properly reporting gains on income tax returns.  As IRS Commissioner Chuck Rettig explained, “the IRS is expanding our efforts involving virtual currency, including increased use of data analytics. We are focused on enforcing the law and helping taxpayers fully understand and meet their obligations.”  This goal was first highlighted in 2014, when the IRS released Notice 2014-21, which stated that virtual currencies like Bitcoin are “property” and are taxable to individuals and businesses that use virtual currencies as (1) a means for sale or exchange, (2) payment for goods and/or services, or (3) holding as investments.  

For federal tax purposes, because virtual currency is treated as property, every time one disposes of virtual currency, whether to trade, sell, as payment for a good or service, etc., it is to be taxed as a capital gain or loss.  To properly report any gain or loss from virtual currencies, taxpayers should file IRS Form 8949 and Form 1040 Schedule D, which apply to short-term and long-term capital assets.

In addition to income tax reporting, one area of ambiguity is whether virtual currencies held in foreign wallets are reportable on FinCEN Form 114, Report of Foreign Bank and Financial Accounts (known as the “FBAR” form).  Taxpayers are required to fill out the FBAR when they have a financial interest in a foreign financial account with an aggregate value of at least $10,000 during the calendar year.  Recently, AICPA Virtual Currency Task Force contacted FinCEN for further clarification on the issue of whether offshore digital wallets are reportable on the FBAR.  FinCEN, surprisingly, responded that virtual currencies held in foreign accounts do not qualify for FBAR reporting.  Despite FinCEN’s comment, it does appear that a foreign cryptocurrency account or wallet would meet the definition of “foreign financial account” and would require an FBAR filing.  The same applies regarding IRS Form 8938, Statement of Specified Foreign Financial Assets, which a taxpayer must file when he or she has certain foreign financial assets with an aggregate value of more than $50,000 (higher for joint accounts). 

As a further example of the IRS taking action against Bitcoin and other digital currencies, in November 2016, a federal court authorized the IRS to issue a John Doe summons to Coinbase, Inc., a web-based digital currency exchange.  Through this summons, the IRS sought records for Coinbase users with a U.S. address, phone number, e-mail address, etc. who traded virtual currencies.  Although Coinbase initially opposed the IRS’s attempts to obtain its client information, Coinbase ultimately revealed its clients’ transactions to the IRS, which allowed the IRS to send out warning letters and audit taxpayers.

“Taxpayers should take these letters very seriously by reviewing their tax filings and when appropriate, amend past returns and pay back taxes, interest and penalties,” stated IRS Commissioner Rettig.  According to the IRS, approximately 10,000 or more taxpayers will receive the new letters.  Though the IRS did not explicitly state from where it obtained these taxpayers’ names, it may be assumed that the John Doe summons against Coinbase provided the IRS with information on specific taxpayers who traded virtual currencies and may not have reported income.

Please contact us if you have received a letter from the IRS regarding tax compliance issues for virtual currencies, as well as if you have other tax-related issues for any other assets – – offshore, onshore or virtual.

Brian Zharov, a student intern, assisted in the drafting of this article.

FBAR and U.S. Tax Reporting: Compliance Requirements for Foreign Assets, a Webinar Presented by Asher Rubinstein on February 6, 2019

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I am pleased to announce that, along with two esteemed colleagues, I will be presenting a webinar on February 6, 2019 at 1pm EST. I will be discussing U.S. reporting requirements for offshore assets, how to come into compliance if you haven’t reported these assets, and what the government might do if you fail to report foreign assets and are discovered. I will also be discussing recent IRS enforcement initiatives for non-reporting of Bitcoin and other crypto currencies. This webinar will also explore how to make a disclosure of offshore assets to the IRS now that the IRS Offshore Voluntary Disclosure Program (OVDP) has ended, as well as additional compliance opportunities, including the IRS Streamlined Disclosure Procedures and the IRS Delinquent Informational Return Procedures.

The panel will review these and other priority issues:

  • Explaining the value of not waiting until the IRS shows up on one’s doorstep to fix offshore filing issues
  • What is the statute of limitations on IRS assessment when taxpayers fail to meet their obligations to report their offshore assets?
  • What are the requirements for the delinquent international information return submission procedures and the delinquent FBAR submission procedures? When does a taxpayer qualify for these procedures?
  • In what ways can the Streamlined Procedures (SDOP/SFOP) and other available programs benefit taxpayers?
  • What are the best practices to implement in determining how these voluntary disclosure programs can work for particular clients?
  • How should tax advisers best navigate the disclosure program requirements?

Additional information may be found at the Strafford website, here.

Coinbase to Provide Client Information to the IRS, Audits to Follow; Take Pre-Emptive Action to Come Into Compliance and Avoid IRS Penalties

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Coinbase, the largest public digital currency exchange, is the target of an IRS summons that seeks information on Coinbase customers who may not have properly reported their profits from trading virtual currencies such as Bitcoin.  We last wrote about Coinbase and the IRS sparring in court, here.  On February 23, Coinbase informed clients that it will be revealing client information to the IRS within twenty one days.  The information to be provided will include client names, taxpayer identification numbers and Coinbase currency transactions.  The IRS will utilize this information to begin audits.

As we’ve written, the IRS offensive against digital currency non-reporting is similar to the way the IRS has pursued foreign banks to uncover “secret” foreign accounts that had not been properly reported to the IRS.  The efforts of the IRS and U.S. Department of Justice eventually led to the death of bank secrecy.

If you have or had an account at Coinbase, and you may not be in IRS compliance regarding your digital currency transactions, now is the time to take pre-emptive action.  We can advise you on how to come into IRS compliance.  Coming into compliance sooner will avoid significant penalties, fees and prosecution.  Once the IRS begins an audit or investigation, pre-emptive action may not be as successful.

Please contact us to discuss IRS compliance for Bitcoin and other virtual currencies.

Please see our earlier articles on virtual currencies and tax compliance:

 

IRS Advances Against Bitcoin Tax Evasion

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We have previously written about the IRS efforts to curtail the use of bitcoin for tax evasion (please see our posts here and here).  In late November, a federal court ordered Coinbase, the largest public digital currency exchange, to comply with an IRS summons and to produce records of clients’ names and transactions.  Once the IRS receives these records, it will begin auditing taxpayers who did not declare and pay tax on their bitcoin (and other virtual currency) gains.  The IRS has declared that bitcoin and other virtual currencies are considered property and are subject to capital gains tax, and the IRS believes that many owners of virtual currencies are not properly reporting gains and paying tax.

The IRS summons against Coinbase is reminiscent of its “John Doe” summons against Swiss bank UBS which sought identifying information on Americans who owned “secret” Swiss bank accounts that were hidden from the IRS.  A “John Doe” summons seeks information from a financial institution (which would include a virtual currency exchange) regarding a broad class of U.S. taxpayers who are not individually named but whom the IRS has reason to believe may have utilized the financial institution to improperly evade tax.  Courts regularly approve such summonses, whereby the IRS obtains information such as the identities of account owners (or, in the case of virtual currencies, wallet owners).  The John Doe summons against UBS was approved by a federal court, which was the first step in the dismantling of Swiss banking secrecy and IRS enforcement against Americans who hid money in Swiss accounts away from the IRS.  The IRS pursued similar summonses against other offshore banks, including in Belize, India, Bahamas, Barbados and the Cayman Islands.

We expect Coinbase to comply with the federal court order and turn over the documents requested in the IRS summons.  This would negate the very anonymity championed by the proponents of bitcoin.  In addition to the John Doe summons against Coinbase, reports have emerged that the IRS is utilizing Chainanalysis, a blockchain forensics firm based in New York, to study bitcoin transactions for tax evasion.  Coinbase also offers “The Shift Card”, which is a debit card that allows a user to spend bitcoin wherever Visa is accepted.  This too can result in tax non-compliance, because if you exchange your bitcoin for goods or services, that too is a taxable event, as the IRS considers you to have earned income on the value of the good or service, less your cost basis in the bitcoin (i.e., your bitcoin purchase price).

When the IRS proceeded against Americans who hid money in Swiss accounts, the IRS at the same time also encouraged the account owners to come forward and declare their foreign accounts and foreign income, in exchange for lower penalties and no criminal prosecution.  This is known as a “voluntary disclosure” by the taxpayer, and it only works if the IRS doesn’t already have the name of the taxpayer.  The IRS may already have the name of the taxpayer from a John Doe Summons, a Swiss bank, an audit, an investigation, the Foreign Account Tax Compliance Act (FATCA) or other ways.  The Offshore Voluntary Disclosure Program (OVDP) resulted in thousands of American taxpayers declaring their foreign assets, paying tax due and avoiding much harsher penalties (and jail time) than if the IRS discovered the foreign assets first.

There is speculation that, like the voluntary disclosure program for foreign assets (which remains ongoing but may be terminated by the IRS at any time), the IRS may offer a voluntary disclosure opportunity for people to come into tax compliance with their virtual currency transactions.  The danger, however, is that the IRS obtains information from Coinbase (or other sources) before the taxpayer comes forward to correct his or her tax noncompliance.  In that case, the IRS will deny the taxpayer’s voluntary disclosure, begin an audit or examination, and assess the full range of penalties rather than the reduced penalties that may apply in a voluntary disclosure.  Timing, as they say, is everything.  Please contact us regarding tax compliance issues for bitcoin or any other assets – – offshore, onshore, or virtual.

Bitcoin Surges in Value Again: Tax Consequences

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As the value a single bitcoin currently exceeds $8,000, bitcoin owners are increasingly on the radar of the IRS.  The IRS has issued guidance (IRS Notice 2014-21) that it considers virtual currency to be property, subject to capital gains tax on profits.  The IRS is also pursuing, in federal court, Bitcoin owners who traded bitcoin at the Coinbase exchange without reporting gains.  Over the last few years, we have advised bitcoin owners on IRS compliance as well as how to lower their capital gains from bitcoin profit.

If you own bitcoin, here are a few important considerations:

When you sell your bitcoin and make a profit, this is a capital gain and is taxable.  One should report bitcoin gain on IRS Form 8949 which is then attached to Schedule D of Form 1040.  The IRS also considers the exchange of bitcoin for goods or services to be a taxable event, the value of the good or service, less the cost basis (purchase price) of the bitcoin.

If you own virtual currency in a foreign account or wallet, there are a set of additional IRS reporting requirements, whether or not you made a profit.  The account is probably reportable on two separate forms:  first, a form called the “FBAR”; second, IRS Form 8938.  If you invested in a foreign fund that invested in bitcoin, the IRS may consider the fund to be a Passive Foreign Investment Company (“PFIC”) that has its own tax methodology, including IRS Form 8621.  Penalties for failing to report foreign assets including virtual currencies are steep, including 50% of the value of the account.

We advise many clients on IRS compliance for their bitcoin (and other) assets, and we also advise them on legal tax minimization strategies for their bitcoin gains.  One popular strategy is a Charitable Remainder Trust.  By contributing appreciated virtual currency to a Charitable Remainder Unitrust, you are entitled to a charitable deduction, regular payments from the trust back to you during the trust term, and at the end of the term, a percentage of the assets passes to the charity, are not subject to income tax and are removed from your estate.

Please contact us to discuss any tax or other compliance issues related to bitcoin.

Please also see our prior articles on bitcoin:

https://www.assetlawyer.com/bitcoin-tax-compliant/

https://www.assetlawyer.com/currency-virtual-real-time-ticking-voluntary-disclosure-virtual-currency/

Now Is The Time To Confirm Your Bitcoin Is Tax Compliant

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The value of Bitcoin has surged 125% in 2017 alone.  In addition to its value ascent, it has also gained in legitimacy.  While it was once the currency of choice on the illicit Silk Road “dark web”, shut down by the U.S. Department of Justice in 2013, Bitcoin is now accepted for payments by Amazon.com and other mainstream businesses.  Whether you’ve weathered the Bitcoin roller coaster or invested recently, you must ensure IRS compliance for Bitcoin.

The IRS has taken an interest in Bitcoin for various reasons.  First, Bitcoin is largely unmonitored and stands apart from the traditional structure of U.S. banking with 1099 forms and regular reporting.  There is a huge mass of Bitcoin value that is relatively unknown to the IRS, and gains in value are essentially hidden from the IRS, and the IRS doesn’t like that.  In addition, Bitcoin has a large potential for tax non-compliance, both because its very nature is anonymous, and because Bitcoin holdings give rise to significant IRS reporting (the “FBAR” form, IRS Form 8938, IRS Form 8949, capital gains taxes, etc.) and many Bitcoin owners don’t heed (or even know) the reporting requirements.

In November 2016, the IRS obtained a federal court authorization 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. taxpayers who are not individually named but whom the IRS has reason to believe may have utilized the financial institution to improperly evade tax.  The John Doe summons upon Coinbase 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.  A recently filed Affidavit by an IRS agent in the Coinbase enforcement litigation revealed that in 2015, only 802 taxpayers revealed Bitcoin information to the IRS on Form 8949, which is the form applicable to capital gains and losses.  Other virtual currency platforms, such as Localbitcoins, Kraken and ItBit may receive similar summonses for transactions with Bitcoins and other virtual currencies like Ethereum and Litecoin.

Bitcoin’s anonymity feeds its non-compliance, and there are many opportunities to run afoul of tax law and IRS requirements, intentionally or inadvertently.  One issue is the failure to report income with respect to Bitcoin.  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.  This means that if Bitcoin is sold for a profit, that profit is income and is subject to capital gains tax.  The income is reportable on IRS Form 8949 which is then attached to Schedule D of Form 1040.  If you exchange your Bitcoin for goods or services, that too is a taxable event, as the IRS considers you to have earned income on the value of the good or service, less your cost basis in the Bitcoin (i.e., your Bitcoin purchase price).

If you are audited by the IRS regarding Bitcoin, you may have to show multiple cost bases for multiple transactions.  Proper record keeping with respect to Bitcoin is essential.  The IRS could take the position that your cost basis in your Bitcoin is zero, and you would pay tax on the full value of the Bitcoin on the date of the transaction, unless you can provide records of your purchases of Bitcoin.

In addition to income tax issues on Bitcoin income, there are reporting issues irrespective of income.  Because a Bitcoin wallet would be considered by the IRS to constitute an “account”, if you hold your Bitcoins in foreign wallets or on foreign Bitcoin exchanges, then foreign account reporting requirements are triggered, including the FBAR (FinCEN Form 114, Report of Foreign Bank and Financial Accounts) and IRS Form 8938 (Statement of Specified Foreign Financial Assets).  If you invested in a foreign fund that invested in Bitcoin, the IRS may consider the fund to be a “PFIC” (Passive Foreign Investment Company), which has its own tax methodology, and IRS Form 8621 would be due.  Penalties for non-reporting foreign accounts are significant, including potentially 50% of the value of the account.

Clearly, the IRS’ increased interest in Bitcoin necessitates proper compliance with respect to Bitcoin assets.  The IRS offers opportunities to come into compliance before the IRS obtains information about unreported assets (virtual or actual) and income, including via a pre-emptive voluntary disclosure (offshore or domestic) of digital currency 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, along with peace of mind and finality.

Please contact us to discuss IRS compliance for Bitcoin assets, along with other tax issues.

Currency is Virtual, but Real Time is Ticking for Voluntary Disclosure of Virtual Currency

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Time is Ticking for Voluntary Disclosure of Virtual Currency 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.