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.