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Taxpayers who have used Bitcoin in the past have probably heard that the IRS is seeking to obtain information about transactions and account holders at Coinbase. Coinbase is one of the largest Bitcoin “exchanges.” People can use Coinbase as a Bitcoin “wallet” and buy, sell, trade, or use Bitcoin to complete purchases for services and goods. Some people have elected to use Bitcoin because they came to believe that these transactions would be 100% anonymous and safe from the prying eyes of friends, neighbors, relatives, or – most importantly – the IRS or other state tax enforcement agencies.
Unfortunately for taxpayers who thought that Bitcoin was the equivalent of a digital invisibility cloak, this conclusion is highly flawed. While Bitcoin does obfuscate a user’s identity, engaging in transactions and using a Bitcoin wallet can render this obfuscation ineffective. While the government is already attempting to exploit this fact through its John Doe summons it served on Coinbase, there is the potential for third parties to willingly provide much this information through the IRS’s whistleblower programs.
Before addressing the IRS’s whistleblower programs it is important to understand why, despite promises of anonymity, Bitcoin and users are vulnerable to having their identity revealed. The reason for this comes down to how the technology functions at a fundamental level.
That is, the promise of Bitcoin is found in the concept of the “blockchain.” The blockchain is basically a technical way of describing something that functions very similarly to a public journal. When a transaction is attempted, it is verified against the public record to ensure the parties have adequate funds to complete the transaction and to verify that the transaction is valid and authentic. Once completed, the transaction is recorded in the “blockchain” where it will be permanently recorded.
Thus, Bitcoin represents something close to a direct contrast to a bank or financial account. In a traditional financial account, the account’s existence and transactions generally remain concealed and out of the public eye. However, the owner of the account is typically identifiable. With Bitcoin, the account and its transactions are always in the public eye but the owner of the account is concealed.
Thus, with Bitcoin, anonymity exists only to the extent you take steps and measures to avoid associating your real identity with your Bitcoin account. If you have signed up for a Bitcoin wallet, you have likely traded your anonymity for convenience. Likewise, if you have revealed the identifier of your account to any other third-party, your anonymity may be as good as gone. The simple fact is this: It only takes a single counter-party to out your identity. Once they have done so, it is possible to extract the account’s entire history from the Bitcoin blockchain.
Individuals who are still skeptical that tech gurus would have the motivation to rat out other taxpayers, consider the fact that the IRS has whistleblower programs that can provide compensation. The amount of compensation that is available to a whistleblower depends upon the amount of tax in controversy. The first whistleblower program concerns instances where the taxes, penalties, interest and other amounts in dispute exceed $2 million, or in the case of an individual, his or her income exceeds $200,000. In this type of scenario, the IRS can pay a whistleblower award of 15 percent to 30 percent of the amount collected. The full rules and regulations for this whistleblower program can be found at IRC Section 7623(b) – Whistleblower Rules. Under Section 7623(b), payment of a whistleblower award is mandated for covered whistleblower disclosures.
If a whistleblower does not qualify under Section 7623(b), they may still choose to proceed under 7623(a). However, under this section payment of a whistleblower award is discretionary rather than mandatory. Furthermore, the maximum reward in this program is capped at 15 percent of the amount in controversy up to a maximum of $10 million. Clearly, it is preferable for a whistleblower to make disclosures under section (b). Whistleblowers who coordinate with counsel before contacting the IRS can take steps to increase the likelihood that mandatory whistleblower award provisions will apply.
Bitcoin Equals Peril for Noncompliant Taxpayers; Potential Opportunity for Tech Savvy Whistleblowers
Thus, depending on whether you complied with Bitcoin tax obligations including capital gains taxes, income taxes, and employment taxes, Bitcoin may represent a potential legal liability. If so, the tax lawyers of the Tax Law Offices of David W. Klasing can assess whether you need to file amended taxes or engage in other actions to mitigate the potential consequences you face. If you happen to hold Bitcoin account or transaction information and believe that you may be a good candidate to act as a whistleblower, we can assess your potential paths forward. To schedule a reduced rate tax consultation with our tax team, call 800-681-1295 today.