IRS Investigations of Virtual Currency May Ramp Up After Congressional Testimony

Last week, the House of Representative’s Financial Services Committee heard testimony from a panel regarding the potential dangers of cryptocurrency. The expert panel discussed how cryptocurrency can be used to perpetuate crimes and how even national security can be placed in jeopardy. The testimony is particularly ripe as many of the ransomware viruses that have circulated around the Internet in the recent weeks have relied on cryptocurrency such as Bitcoin as the exclusive currency by which to pay a ransom to retrieve data that has been held digitally hostage.

 

Witnesses on the panel agreed that the larger security threat wasn’t with virtual currencies such as Bitcoin themselves, but rather with the unlicensed and unregulated virtual currency exchanges outside of the United States and Western Europe. Furthermore, the panel of experts stated that the greatest danger to society occurs when criminals deal with virtual currency for illicit purposes within the unregulated exchanges.

 

A common misconception among those using Bitcoin or other virtual currencies as a part of criminal activities is that it is a trace-free way to transfer money or to make purchases. In reality, cryptocurrency is becoming one of the most traceable ways to transact.  Startup companies like Elliptic are working with law enforcement to track the identity of those behind online transfers of Bitcoin and other virtual currencies that are suspected of being connected to criminal behavior.

 

One of the groups that is most interested in who is behind the purchase and sale of cryptocurrencies is the IRS. Late last year, the IRS requested a federal court to issue a John Doe summons to compel U.S.-based virtual currency exchange Coinbase to turn over the names of all of its customers to the IRS. After the federal court granted the summons, Coinbase and a Coinbase customer filed motions to intervene in the case and prevent the summons from being enforced. Hearings were scheduled to determine whether Coinbase and its representative customer would be able to intervene, but those motions were withdrawn after the United States filed a petition to enforce the summons, giving Coinbase the ability to challenge the potentially overbroad nature of the summons without evidence of any wrongdoing by any particular Coinbase users.

 

The position of the IRS is that virtual currency such as Bitcoin is property. Taxpayers obtain a cost basis in the virtual currency when they purchase it or exchange something of value for it. When the taxpayer disposes of the virtual currency, gain is realized and recognized to the extent that the fair market value of the consideration received exceeds the taxpayer’s basis in the virtual currency. The IRS announced recently that they believe that only a few hundred taxpayers reported gains from the disposition of virtual currency annually and that many taxpayers are failing to report such gains. It is the goal of the IRS to get a glimpse of Coinbase’s number of users and their users’ transactions of virtual currencies that may have given rise to taxable gain.

 

If you have significant holdings in virtual currencies or are a Conbase member, the government has aimed their sights in your direction. It is in your best interest to consult with an experienced Bitcoin tax attorney to develop a sound strategy to mitigate any potential risks of dealing with Bitcoin or similar virtual currency. A tax defense attorney understands the examination process and other enforcement proceedings that the IRS may attempt to employ in order to expose virtual currency transactions.

The tax and accounting professionals at the Tax Law Offices of David W. Klasing have extensive experience in representing taxpayers from varying walks of life. Whether you are a small business owner or a virtual currency investor, our tax professionals are standing by to ensure that your tax strategy is aligned with the bigger picture of keeping you out of trouble with the tax authorities. Don’t lose sleep over whether the IRS will discover your virtual currency trading account. Contact the Tax Law Offices of David W. Klasing today for a reduced-rate consultation.

 

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Here is a link to our practice overview video on warning signs than an audit has gone criminal.