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The federal government is not waiting around for taxpayers to self-report their gains from the exchange of cryptocurrency.

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    In a legal battle that began last year and has continued into 2017, the IRS is attempting to force the release of virtual currency broker’s customer records. After suspecting that only a few hundred taxpayers nationally were reporting gains for virtual currency transactions, the IRS convinced a federal judge to grant a John Doe summons against Coinbase, a virtual currency broker. The John Doe summons requests detailed information about Coinbase’s customers and their cryptocurrency transactions. Coinbase and its customers fought back and the case is currently pending an enforcement hearing.


    The federal government recognizing the legitimacy of blockchain and other technology that has developed because of virtual currency is certainly a win for technology and innovation but is a warning shot for taxpayers who are currently investing in cryptocurrency.


    States Passing Laws Addressing Blockchain, a Cryptocurrency Technology

    Several states around the country have enacted laws or have issued guidance focused on the legitimacy of blockchain as a legal record evidencing a transaction. Although the new blockchain legislation is not directly related to cryptocurrency, the state governments’ actions show that authorities are aware of emerging technologies and their legal implications. This also means that tax authorities are keenly aware of the large amount of transactions involving virtual currency and will be enforcing tax laws on all virtual currency transactions, including the exchange of bitcoin.


    What is blockchain?

    In the most simplistic of terms, blockchain is an electronic transaction record or an electronic ledger. It was originally created to track transactions involving bitcoin, but has now expanded to other types of exchanges. Each transaction is recorded in a “block” and contains a timestamp. Additionally, the block contains a link to a previous block. Peer-to-peer networks validate the addition of new blocks by following specific protocols. Blockchains are effectively open ledgers that contain verifiable transactions between parties that are extremely difficult to manipulate or falsify.


    Since blockchain’s conceptualization in 2008, the technology expanded to other uses. Known as “Blockchain 2.0”, blockchain was being used in the creation of “smart contracts” that were capable of performing payment functions of contracts without manual input. Such uses could include paying dividends once a certain level of earnings has been attained or making invoice payments once a service have been provided or goods have been received. In essence, blockchain is allowing the automation of contract obligations and more. Notwithstanding the innovations in blockchain technology, a large majority of its use is still within the cryptocurrency trade.


    What are states saying about blockchain?

    Recently, Nevada and Arizona have passed laws that prevent local governments from charging for the use of blockchains, whether through taxes or fees. Furthermore, governments in those states cannot require additional documentation such as permits, certificates, or licenses to use a blockchain. Finally, the law recently passed in Nevada states that if a transaction/event must be recorded, the electronic creation of a block in a blockchain is sufficient.


    The federal government has had little to say about the use of blockchains, though the Treasury Department has addressed the tax treatment of virtual currency. Internal Revenue Bulletin 2014-16 explains that the general principles relating to the transfer of property apply to the transfer of virtual currency such as Bitcoin.  Thus, when a taxpayer acquires virtual currency, they receive a cost (or in certain cases, a carryover) basis in the property. Upon the disposition of the virtual currency, a taxpayer will realize and recognize gain to the extent that the fair market value of the money or property received in the transfer exceeds their basis in the virtual currency.


    What is the Bottom Line Here?

    If you are one of the millions of US residents that has transacted in Bitcoin or another virtual currency and have not correctly reported gain from your transactions on your annual tax return, you may be at risk. The IRS has made it clear that it will try to track down those trading cryptocurrencies and ensure that they are complying with state and federal tax laws. If you have engaged in the exchange of virtual currency and failed to report your gain, it is in your best interest to contact a Bitcoin / Cryptocurrency Tax Attorney.


    The tax and accounting professionals at the Tax Law Offices of David W. Klasing have extensive experience in representing taxpayers from all walks of life in a myriad of different tax scenarios. Those engaging in the trade of cryptocurrency deserve representation from a Tax Defense Attorney who has an appreciation of bitcoin and other virtual currency and the tax implications surrounding them. Our team of zealous advocates will develop a plan that fits your particular needs and concerns. Contact the Tax Law Offices of David W. Klasing today for a reduced-rate consultation.


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