Bitcoin is a still-emerging virtual currency technology that permits individuals and businesses to send, accept, and hold digital currency online. Bitcoin functions as a decentralized network where users contribute computing resources to maintain the public block chain; the block chain is a history of all transactions that have ever been conducted in Bitcoin. Users who contribute computing resources towards maintaining this public ledger are said to be mining Bitcoin. Individuals who contribute resources to mine Bitcoin can be compensated for their time in resources through the award of Bitcoin.
While many people are interested in Bitcoin for both technological and investing reasons, a failure to understand Bitcoin’s tax treatment can lead to serious consequences. Recent IRS actions to obtain account records and identities of all U.S. Coinbase accountholders, should be concerning to all individuals who have used Bitcoin. Individuals with significant Bitcoin transactions are likely to find themselves targeted by the IRS if they have failed to account for capital gains or used Bitcoin to avoid paying taxes on income.
In September 2016, TIGTA issued a report titled As the Use of Virtual Currencies in Taxable Transactions Becomes More Common, Additional Actions Are Needed to Ensure Taxpayer Compliance, Reference Number 2016-30-083, Sept. 21, 2016. In the report, TIGTA wrote that taxpayer use of virtual currencies, like Bitcoin, had expanded significantly in recent years. The report reflects TIGTA’s belief that while there are legitimate reasons to use virtual currency, some taxpayers are attracted to the ostensible anonymity that the platform can offer. TIGTA believes that many people are attracted to this sense of anonymity because they wish to engage in illegal acts or transactions including tax evasion.
TIGTA’s report noted the IRS’s Notice 2014-21, Virtual Currency Guidance report and the establishment of its virtual currency team. However, the report concluded that the IRS divisions had failed to coordinate and none had developed “compliance initiatives or guidelines for conducting examinations or investigations specific to tax noncompliance related to virtual currencies.” Thus, TIGTA recommended for the IRS to develop a coordinated virtual currency strategy to identify and prosecute this emerging form of tax evasion. It appears that this strategy was developed and is now being implemented by the IRS.
News that the IRS has issued summons to Coinbase should place individuals on notice that they need to take action to correct Bitcoin tax mistakes as soon as possible. The IRS is permitted to petition to obtain the identities of these account holders under 26 U.S.C. 7609(f). Under the statute, the IRS carries its burden when:
(1) the summons relates to the investigation of a particular person or ascertainable group or class of persons,
(2) there is a reasonable basis for believing that such person or group or class of persons may fail or may have failed to comply with any provision of any internal revenue law, and
(3) the information sought to be obtained from the examination of the records or testimony (and the identity of the person or persons with respect to whose liability the summons is issued) is not readily available from other sources.
Generally speaking, the IRS boasts incredibly high rates of success when it goes to court. The agency has already successfully used John Doe summons to uncover the identity of U.S. taxpayers holding offshore bank and other accounts.
In the Coinbase matter, on November 30, 2016, the United States District Court for the Northern District of California granted the IRS’s request to serve John Doe summons. This means that all U.S. taxpayers who held a Coinbase account at any time during 2013, 2014, or 2015 are highly likely to have their information turned over to the government. While Coinbase has vowed to fight the summons, it is unlikely that it will be able to stop the release of these records.
Since the value of Bitcoin has trended upwards since at least 2013, if you held or conducted transactions with Bitcoin or other similar virtual currencies on Coinbase, it is likely that you were and are subject to capital gain taxes. If you mined Bitcoin and engaged in subsequent transactions, you likely owe income tax on the compensation you received plus capital gain taxes. If you have failed to pay these taxes or used Bitcoin as a means to conceal other income, you should immediately contact a tax attorney to discuss whether you should be concerned about tax evasion or other tax enforcement actions.
The tax attorneys and tax professionals of the Tax Law Office of David W. Klasing can work to mitigate the consequences you face for Bitcoin tax compliance failures. Mr. Klasing is a dually certified tax attorney and CPA who has more than 20 years of experience. As a former public auditor, he can often develop a tactical approach to minimize the damage caused by tax non-compliance. To schedule a confidential, reduced rate consultation call our Irvine or Los Angeles law offices at 800-681-1295 today.