Cryptocurrency (in this article, referred to as virtual currency and cryptocurrency, interchangeably), is one of the hottest topics in IRS civil and criminal tax enforcement. The IRS has been relatively quiet regarding the tax treatment of virtual currency transactions but has been very vocal about its willingness to criminally investigate and prosecute taxpayers who are willfully noncompliant in reporting such dealings. This article explores the IRS current enforcement actions relating to cryptocurrency, the limited guidance that has been released on the topic, and considerations for taxpayers looking to come into “crypto-compliance”.
Ramping-Up of Cryptocurrency Enforcement Actions
Before the 2019 tax year, taxpayers were required to report cryptocurrency transactions the same way that they would report any other transactions involving capital assets. There were no special forms to complete or virtual currency-specific line items on IRS forms. But with the updated Form 1040 for 2019 comes a question on Schedule 1 inquiring as to whether the taxpayer received, sold, sent, exchanged, or otherwise acquired a financial interest in virtual currency in 2019.
Although the “Yes” or “No” question may seem insignificant to some, it serves three primary functions. First, the inquiry will help the IRS understand exactly how many taxpayers have dealt in cryptocurrency in 2019. Second, the question will help the IRS easily determine whether a taxpayer is involved in cryptocurrency trading. Lastly and most importantly, it serves as a glaring notice to taxpayers that the IRS is holding them accountable to accurately and truthfully report cryptocurrency transactions.
The IRS has not been shy about using their toolbox of investigatory weapons to weed out those who are not truthfully reporting cryptocurrency transactions. In 2016, the IRS fought tooth and nail in federal court to demand records from Coinbase, a California-based virtual currency exchange. In that case, the IRS was not even looking for any one taxpayer, specifically. The Service simply issued a summons for a mass amount of data on Coinbase’s customers. Other coin brokerages are thought to have also received John Doe Summonses.
A Warning to Taxpayers
What does all of this really mean for taxpayers? The IRS Criminal Investigation unit has made it known that virtual currency tax enforcement is one of their top priorities for 2020 and beyond. With more and more taxpayers engaging in cryptocurrency transactions, the IRS has an increased incentive to crack down on those who have not truthfully reported their cryptocurrency dealings on their annual tax returns.
IRS Guidance on Cryptocurrency (or lack thereof)
In 2014, the IRS released Notice 2014-21. The guidance, which marked the first of its kind released by the Service with respect to virtual currency, established the official position that for federal tax purposes, cryptocurrency is property, subject to all of the same tax principles applicable to dealings in property.
Five years passed before the IRS expanded on its 2014 Notice. Rev. Rul. 2019-24 provides additional guidance intended to assist taxpayers understand the tax consequences of some of the more technical nuances of cryptocurrency, specifically the technical tax result of a hard fork and airdrops following hard forks. Finally, the IRS accompanied Rev. Rul. 2019-24 with a frequently asked questions resource.
GAO Criticism of the IRS Adds to Cryptocurrency Confusion
IRS guidance from 2014 and 2019 aside, important players within the government think that the Service has fallen short on its obligation to properly inform taxpayers as to their tax obligations relating to cryptocurrency and official IRS positions. The Government Accountability Office recently called on the IRS to issue additional guidance to help taxpayers navigate the compliance hoops that are being constructed and to provide a deeper level of insight into the tax treatment of cryptocurrency transactions.
The GAO’s call on the IRS comes as a result of the Service’s failure to publish large portions of the 2019 guidance in the Internal Revenue Bulletin. Historically, the IRS has taken the position that only guidance that is published in the Internal Revenue Bulletin may be relied upon by taxpayers. The GAO further recommended that if the IRS did not wish for taxpayers to rely on the 2019 guidance, they should include a disclaimer in the guidance indicating that the guidance is not binding.
Coming into Crypto-Compliance
Taxpayers who bought or sold virtual currency for the first time in 2019 are responsible for accurately completing their respective Form 1040, which includes a direct question relating to cryptocurrency activity on Schedule 1. Taxpayers who have traded virtual currency in past tax years and should have recognized capital gains, but failed to do so, have a serious tax exposure.
If you have offshore cryptocurrency and failed to report your ownership or transactions in prior years, the streamlined voluntary disclosure program may be the right answer for you. Under the terms of the program established in 2012, a taxpayer must come forward and acknowledge that he or she failed to report foreign financial assets and that the failure was not willful. If you would have to include $30,000 or more (one year in jail under the federal sentencing guidelines) of additional federal income tax on one or more amended federal tax returns to pick up your previously omitted crypto trading and there are badges of fraud in your fact pattern and you are seeking a nearly guaranteed pass on criminal tax prosecution, you should discuss an IRS Criminal Investigation Voluntary Disclosure with an experienced and qualified criminal tax defense attorney.
If you own or have traded in cryptocurrency prior to 2019 that went unreported, it is in your best interest to consult with an experienced cryptocurrency tax attorney. Together, you and your tax counsel can establish the pertinent facts of your virtual currency dealings and determine what the best course of action is on a go-forward basis. Whether your strategy involves the streamlined voluntary disclosure program or another method, your tax attorney will work to ensure that the risks of financial and criminal tax penalty are mitigated as much as the law allows.
Contact an Experienced Tax Attorney Today
The tax and accounting professionals at the Tax Law Offices of David W. Klasing have extensive experience representing taxpayers who have engaged in virtual currency transactions. Whether you only dabble or are a serious cryptocurrency trader, our team of zealous advocates will assist in the development of a strategy to help you reach your specific goals and objectives and work to keep you safe from a crypto investigation. Whether you are under a tax examination or are in need of tax planning advice, contact the Tax Law Offices of David W. Klasing today, online or by phone at (800) 681-1295, for a reduced-rate consultation.
If you are under audit and have substantial unreported cryptocurrency transactions in your fact pattern, you are facing an eggshell audit and should hire a criminal tax defense attorney to represent you. Stay away from the original preparer as they are likely to be government witness number one against you should the government bring a criminal prosecuted for tax crimes. They are also facing a conflict of interest in that they may be motivated to damage your reputation to protect their own.
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