In recent years, many people have become interested in emerging financial applications of cryptography and decentralized peer-to-peer networking. While the first digital currency to leverage these and other technologies, a score of competing cryptocurrencies have since emerged on the scene. Some of the benefits of Bitcoin and similar technologies include:
There is no bank, credit card processor, or other middleman to take a cut of the payment.
Transactions are verified and authenticated before money is ever transferred.
Users do not need access to special hardware, payment cards, or other single-purpose devices to use cryptocurrency.
User’s identities are protected to a certain extent.
The last bullet point is particularly noteworthy. While Bitcoin and similar digital currencies are often advertised as “anonymous” the fact of the matter is that this generally refers to the fact that people can send and receive money without directly revealing personally identifiable information.
However, far too many people misinterpret that last point and believe that once money is “in” Bitcoin, it is invisible to the IRS and U.S. government. This is a faulty assumption that can lead to an audit, tax enforcement actions, and even criminal tax evasion charges. Read our story about “Tax Fraud is Going Virtual” to know more about virtual tax evasion.
Bitcoin Does Not Provide Perfect or Reasonable Anonymity in Many Scenarios
Bitcoin functions by making a public ledger containing all transactions ever conducted available. Thus, by nature, all transactions are publicly available. Thus, there is no such thing as a “private” Bitcoin transaction. Rather, a level of anonymity is preserved by disassociating a user’s identity with the public transaction – however a record of the transaction time, amount, and other information is always kept publicly. The problem that exists is when users sign up with popular Bitcoin wallet services, their identity is revealed in an e-mail. For users who use Bitcoin in this method, it is no more anonymous or private then a bank transaction.
The IRS Is Using John Doe Summons to Unmask Cryptocurrency Account Holders
The IRS is aware of this potential vulnerability in the Bitcoin security and anonymity model and is attempting to leverage it to reveal the identity of all customers of the largest Bitcoin exchange, Coinbase. The summons requests “the identities of United States Coinbase customers who transferred convertible virtual currency at any time between December 31, 2013, and December 31, 2015.” This tactic was used to successfully crack down on UBS, offshore tax evasion, PayPal, and a number of credit card companies.
By sending the John Doe summons, the IRS seems certain that it will uncover at least some individuals engaged in tax evasion because the summons profess a reasonable basis for believing that United States taxpayers have failed to comply with the internal revenue laws. In fact, this new gambit arises from, at least, three earlier cases where the IRS and DOJ prosecuted Bitcoin tax evasion by users of Coinbase.
What Should I do If I Had a Coinbase or Bitcoin Wallet Account in 2014, 2015, or 2016 and Failed to File and Pay Taxes?
If you had a Coinbase account or otherwise mined, held, traded, or engaged in transactions involving Bitcoin it is essential to take steps to mitigate the potential consequences you face and you may need to file an FBAR. This may include amending past tax returns, filing missed returns, or making voluntary disclosures. The IRS has already taken steps to identify those taxpayers who are utilizing Bitcoin and cryptocurrency to commit tax evasion. As the IRS continues to gather information from an array of domestic and international financial institutions, it is highly likely that it will become increasingly aggressive in its enforcement activities.