In an increasingly digitized world, more and more of our financial transactions are carried out online, from small personal exchanges on PayPal and Venmo to multi-million-dollar international business deals. It seems that in such a technological climate, it was only a matter of time before businesses and individuals adopted the use of “cryptocurrency” or “virtual currency,” the best-known example of which is inarguably “Bitcoin.” Bitcoin, which was traded for the first time in 2010, is an open-source, peer-to-peer, decentralized currency that can be converted into USD, EUR, and other traditional currencies. So, how and when should taxpayers report Bitcoin and other Cryptocurrencies taxable activity to the Internal Revenue Service (IRS)? And, perhaps most importantly, what future developments might Bitcoin traders expect to encounter as the IRS establishes a more rigid regulatory framework?
IRS Issuing John Doe Summonses to Find Taxpayers Who Buy or Sell Bitcoin
Bitcoin was traded for the first time in February 2010. Far from proving a failed experiment, Bitcoin generated an explosion of interest among the tech-savvy, the privacy-minded, and the curious, increasing in value from $600 a coin in mid-2016 to its current value of $11,839.99 per coin. It takes only a glance at the chart below, captured from a simple Google search, to see the astounding rate of growth in Bitcoin’s value over the past several years.
With a single Bitcoin valued at just under $11,840 as of late 2017, it is unsurprising that the IRS has plans to increase scrutiny of Bitcoin miners, users and investors. Prompted by the American Institute of Certified Public Accountants (AICPA), which requested additional guidance as the IRS’ initial commentary on Bitcoin, contained in Notice 2014-21, grew outdated, the Treasury Inspector General for Tax Administration (TIGTA) released a September 2016 report (“As the Use of Virtual Currencies in Taxable Transactions Becomes More Common, Additional Actions Are Needed to Ensure Taxpayer Compliance”), viewable in full here, providing greater detail.
In the report, “TIGTA recommended that the IRS: 1) develop a coordinated virtual currency strategy that includes outcome goals, a description of how the agency intends to achieve those goals, and an action plan with a timeline for implementation; 2) provide updated guidance to reflect the necessary documentation requirements and tax treatments needed for the various uses of virtual currencies; and 3) revise third-party information reporting documents to identify the amounts of virtual currencies used in taxable transactions.” In other words, TIGTA recommended that the IRS implement clearer standards – and more aggressive enforcement policies – for tracking Bitcoin and other Cryptocurrencies and its users, investors and miners. (After all, according to an article recently published in Forbes, the “IRS claims that,” among 208 million of returns filed in 2015, “only 802 people declared a capital gain or loss related to [B]itcoin in 2015.”)
IRS Bitcoin Reporting Requirements: Capital Gains, FATCA, and FBAR
The IRS clearly took the TIGTA report to heart. Within months of receiving these recommendations, the IRS commenced issuing “John Doe” summonses, which are used in situations where the taxpayer’s identity is unknown, to obtain information about customers who buy or sell Bitcoin through Coinbase, a virtual currency hub which describes itself as “the world’s most popular way to buy and sell” not only Bitcoin, but also its lesser-known cousins “Ethereum” and “Litecoin.” If you or an institution you trade with have received a summons pertaining to Bitcoin or other Cryptocurrency, you should contact a tax defense attorney immediately.
It will likely take months, perhaps years, for the complex litigation surrounding Bitcoin, Coinbase, and the IRS to resolve. However, as of December 2017, there are at least three identifiable Bitcoin reporting requirements of which buyers and sellers should be aware:
- Capital Gains Reporting Requirements – “Capital gains” are simply profits earned from selling capital assets, such as vehicles, real property, and investment property. Though included in taxable income, capital gains are typically taxed at a lower preferential tax rates than other ordinary sources of income, such as wages. Bitcoin and other Cryptocurrency capital gains (and conversely, capital losses) must be disclosed using Form 8949 (Sales and Other Dispositions of Capital Assets).
- FATCA Reporting Requirements – FATCA refers to the Foreign Account Tax Compliance Act, under which foreign financial institutions (FFIs) are required to “report on the foreign assets held by their U.S. account holders.” Though FFIs are usually banks, the term could also include foreign Bitcoin exchanges or offshore cryptocurrency wallets. If you are holding $50,000 or more in Bitcoin with an FFI, you may be required to file Form 8938 (Statement of Specified Foreign Financial Assets).
- FBAR Reporting Requirements – FATCA requirements are sometimes conflated with FBAR requirements, which are similar but distinct. Critically, the reporting threshold for FBAR is much lower – $10,000 compared to $50,000 under FATCA – meaning more taxpayers are impacted. To quote the IRS, “If you have a financial interest in or signature authority over a foreign financial account, including a bank account, brokerage account, mutual fund, trust, or other types of foreign financial account” – now including Bitcoin or Cryptocurrency – you may be required to file an FBAR (Report of Foreign Bank and Financial Accounts) using FinCEN Form 114, which must be submitted electronically.
Note that steep civil and even potential criminal penalties may be imposed for simply negligent or outright willful failure to comply with any of these requirements, nor are these necessarily the only requirements to which taxpayers in possession of Bitcoin and other Cryptocurrencies may be subject.
Irvine CPA-Attorneys Can Help You Report Bitcoin to Avoid Penalties
While neither the future nor the stability of Bitcoin and Cryptocurrency, in general, are guaranteed – indeed, some tech industry experts are already predicting a burst in the bubble – the currency’s skyrocketing value seems to foreshadow a regulatory clampdown. If you’re currently trading in Bitcoin and other Cryptocurrencies, use them to compensate your employees, or to pay for personal expenses, or are investing in them for retirement or other savings, it is in your best interests to carefully review your Bitcoin and other Cryptocurrency compliance with an experienced tax attorney who is knowledgeable in this emerging area of tax law.
The sooner you begin reviewing your reporting requirements with a Bitcoin tax attorney, the easier it will be to mitigate or completely avoid penalties, while simultaneously ensuring that you lay the foundation for smart financial tax planning. To schedule a reduced-rate consultation with the trusted Irvine tax lawyers of the Tax Law Office of David W. Klasing, contact us online or call (800) 681-1295 today to discuss Bitcoin compliance confidentially.
Also, we’ve expanded our offices! In addition to our offices in Irvine and Los Angeles, the Tax Law Offices of David W. Klasing now have offices in San Bernardino, Santa Barbara, Panorama City, and Oxnard! You can find information on all of our offices here.
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