IRS Steps Up Focus on Cryptocurrency
The Agency's recent flurry of letters to cryptocurrency owners sheds a little overdue light on its thinking.
In 2014 the IRS made clear that virtual currency (which includes “cryptocurrency”) is to be treated as “property” for tax purposes, and not as “currency,” and as such, transfers of virtual currency are subject to capital gain (or loss). However, and despite promises to do so as recently as May 2019, the IRS did not clarify the details of how to compute, assign, and document cost basis and handle other issues unique to cryptocurrency. Now, a recent flurry of IRS letters to cryptocurrency owners suggests the IRS has significantly increased its focus on this relatively new type of asset.
IRS Notice 2014-21: Cryptocurrency as “property”
IRS Notice 2014-21 clarified that for tax purposes, virtual currency is treated as “property” and not as currency. (This means if cryptocurrency is used to purchase other property or services, the transaction is a taxable event whereby either capital gain or loss on the cryptocurrency itself is realized at the time of the purchase.) But specific guidance about acceptable methods for calculating, assigning, and documenting cost basis was not included in the 2014 Notice.
IRS: Cryptocurrency guidance coming "soon"!
Fast-forward five years -- still no guidance.1 On April 11, 2019, U.S. Rep. Tom Emmer, a member of the Congressional Blockchain Caucus, along with twenty other members of Congress, sent a letter to IRS Commissioner Charles Rettig requesting guidance on the tax consequences and basic reporting requirements for taxpayers who use virtual currencies. Rep. Emmer’s letter noted that it had been (a) over a decade since the IRS National Taxpayer Advocate identified, in its 2008 Annual Report, that the tax treatment of virtual currency was one of the most serious problems encountered by taxpayers; (b) nearly five years since the IRS released preliminary guidance on the issue (IRS Notice 2014-21); and (c) over two years since the Inspector General for Tax Administration found the 2014 guidance lacking and recommended IRS action.
On May 16, 2019, Commissioner Rettig responded to Rep. Emmer’s letter, acknowledging the need for “clarity on basic issues related to the taxation of virtual currency transactions,” and noting that the IRS is working on guidance for “acceptable methods for calculating cost basis, acceptable methods of cost basis assignment, and the tax treatment of “forks.” Commissioner Rettig wrote that the IRS intended to publish guidance on these and other issues “soon.”
IRS letters to cryptocurrency owners
The continuing lack of guidance notwithstanding, in July and August 2019, the IRS reportedly sent more than 10,000 warning and action letters to cryptocurrency owners. The letters consisted of three different versions: IRS Letters 6173, 6174, & 6174-A. According to the IRS, names of targeted cryptocurrency owners were obtained “through various ongoing IRS compliance efforts.” (IR-2019-132) (These "efforts" may have included some of the 14,000 names released by Coinbase in 2018 in response to a successful lawsuit brought by the IRS.)
IRS Letter 6174 and IRS Letter 6174-A, neither of which requires a response, may be read as “educational” in nature, but they also serve as a warning to the extent they advise taxpayers to review their tax returns in light of information provided about virtual currency reporting and taxation requirements, and to amend returns and pay back taxes (including interest & penalties) as required. Letter 6174-A adds a further caution that the IRS “may send other correspondence about potential enforcement activity in the future.”
IRS Letter 6173 is an “action” letter -- much more severe in tone -- which requires a response by a specified date, wherein the taxpayer must either (a) file delinquent returns or amend returns that did not correctly report virtual currency transactions, or (b) describe how the virtual currency transactions were correctly reported on previously filed returns. Letter 6173 also warns that the IRS will crosscheck the taxpayer’s response “against information received from banks, financial advisors, and other sources for accuracy,” specifically warns of the potential for audits, and requires signature under penalty of perjury.
What should cryptocurrency owners do?
If cryptocurrency is part of your asset mix (and certainly if you receive a letter from the IRS about your cryptocurrency tax compliance), you should seek advice from an appropriate, experienced tax professional as to applicable reporting requirements and liabilities. For any potentially fraudulent acts with respect to cryptocurrency reporting, or if you were specifically targeted by the IRS (especially if you are the recipient of an IRS “action” letter regarding cryptocurrency reporting), it is recommended you seek professional advice from a tax attorney.
Additional IRS guidelines likely will be issued in the coming months, and it is important to be on alert for this new information. In the meantime, however, tax compliance with respect to cryptocurrency is fully required for current and prior tax years. It appears that, as with offshore accounts during the past decade, the IRS views cryptocurrency account activity as a significant arena of taxable transactions (and tax revenue) and one that it does not intend to overlook.
1As this article was going to press, the IRS released -- on October 9, 2019 -- some of its long-promised guidance for virtual currency tax compliance (IR 2019-167): IRS Revenue Ruling 2019-24, which discusses tax treatment related to “forks,” and a posting on its website of 43 “Frequently Asked Questions” regarding taxation of virtual currency transactions.
A couple of days later, the IRS debuted another virtual currency compliance measure when it circulated an early release draft of the 2019 Form 1040, Schedule 1 (“Additional Income and Adjustments to Income”) which begins with the following new question:
“At any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?” (Checkbox: “Yes” or “No”)
Yes, the IRS wants to know about your cryptocurrency.
Note: This article is intended to provide general background information only and does not address any particular cryptocurrency tax compliance situation. You should consult an appropriate, experienced tax professional with respect to your particular cryptocurrency tax compliance situation.
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