IRS Still Enforcing Rule Requiring Taxpayers To Report All Cryptocurrency And Digital Asset Income On Their 2023 Federal Income Tax Returns

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IRS Still Enforcing Rule Requiring Taxpayers To Report All Cryptocurrency And Digital Asset Income On Their 2023 Federal Income Tax Returns

Since 2019, Forms 1040 series, Individual Income Tax Return, includes the following checkbox question:

At any time during the year, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?   ◊ Yes            ◊ No

For the 2023 tax year, that wording has changed slightly and has been added to Form 1041, U.S. Income Tax Return for Estates and Trusts; Form 1065, U.S. Return of Partnership Income; Form 1120, U.S. Corporation Income Tax Return; and Form 1120-S, U.S. Income Tax Return for an S Corporation.

Depending on the form, the digital assets question asks this basic question, with appropriate variations tailored for corporate, partnership or estate and trust taxpayers:

At any time during 2023, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, or otherwise dispose of a digital asset (or a financial interest in a digital asset)?   ◊ Yes            ◊ No

With more businesses willing to accept and transact in cryptocurrencies, the absence of specific rules related to the reporting of business income from cryptocurrency transactions has created a “tax gap” that the IRS intends to close.

What is a digital asset?

A digital asset is a digital representation of value that is recorded on a cryptographically secured, distributed ledger or any similar technology. Common digital assets include:

  • Convertible virtual currency and cryptocurrency.
  • Stablecoins.
  • Non-fungible tokens (NFTs).

Everyone must answer the question

Everyone who files Forms 1040, 1040-SR, 1040-NR, 1041, 1065, 1120, 1120 and 1120S must check one box answering either “Yes” or “No” to the digital asset question. The question must be answered by all taxpayers, not just by those who engaged in a transaction involving digital assets in 2023.

When to check “Yes”

Normally, a taxpayer must check the “Yes” box if they:

  • Received digital assets as payment for property or services provided;
  • Received digital assets resulting from a reward or award;
  • Received new digital assets resulting from mining, staking and similar activities;
  • Received digital assets resulting from a hard fork (a branching of a cryptocurrency’s blockchain that splits a single cryptocurrency into two);
  • Disposed of digital assets in exchange for property or services;
  • Disposed of a digital asset in exchange or trade for another digital asset;
  • Sold a digital asset; or
  • Otherwise disposed of any other financial interest in a digital asset.

How to report digital asset income

In addition to checking the “Yes” box, taxpayers must report all income related to their digital asset transactions. For example, an investor who held a digital asset as a capital asset and sold, exchanged or transferred it during 2023 must use Form 8949, Sales and other Dispositions of Capital Assets, to figure their capital gain or loss on the transaction and then report it on Schedule D (Form 1040), Capital Gains and Losses. A taxpayer who disposed of any digital asset by gift may be required to file Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return.

If an employee was paid with digital assets, they must report the value of assets received as wages. Similarly, if they worked as an independent contractor and were paid with digital assets, they must report that income on Schedule C (Form 1040), Profit or Loss from Business (Sole Proprietorship). Schedule C is also used by anyone who sold, exchanged or transferred digital assets to customers in connection with a trade or business.

When to check “No”

Normally, a taxpayer who merely owned digital assets during 2023 can check the “No” box as long as they did not engage in any transactions involving digital assets during the year. They can also check the “No” box if their activities were limited to one or more of the following:

  • Holding digital assets in a wallet or account;
  • Transferring digital assets from one wallet or account they own or control to another wallet or account they own or control; or
  • Purchasing digital assets using U.S. or other real currency, including through electronic platforms.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

How The IRS Finds Noncompliant Taxpayers

The IRS and other federal agencies have access to extensive troves of data in the worldwide web of bitcoin and other cryptocurrencies.  Chainalysis is a company that created a cryptocurrency-tracing software dubbed “Reactor” which is being used by at least 10 federal agencies including the IRS.  The IRS Cyber Crimes Unit (CCU), a division of its larger Criminal Investigation (CI) wing and the leader in the IRS’ cryptocurrency crimes investigations, uses this software as a tool to help identify taxpayers who could be non-compliant in the tax laws or involved in criminal activity.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Cryptocurrency Transactions.

IRS will also issue Summonses to institutions involved in cryptocurrency to secure information on their accountholders.  One of the first John Doe Summons in cryptocurrency area issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase was required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent). On March 16, 2018 Coinbase complied with this Summons and turned over data of 14,355 accountholders to the IRS.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS!

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

What Should You Do?

The IRS suspects that there are still crypto users that have been evading taxes by not reporting crypto transactions on their tax returns.  With IRS’ continued focus in this area and commitment of more resources for enforcement, now is the ideal time to be proactive and come forward with voluntary disclosure to eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.

Take control of this risk and engage a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Bay Area (San Francisco, San Jose and Walnut Creek) and other California locations.  We can come up with solutions and strategies to these risks and protect you and your business to mitigate criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.

 

Why Taxpayers Involved In Offshore Accounts, Cryptocurrency Or Cannabis Should Be Filing An Extension For Their 2022 Income Tax Returns.

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Why Taxpayers Involved In Offshore Accounts, Cryptocurrency Or Cannabis Should Be Filing An Extension For Their 2022 Income Tax Returns.

If you did not report your offshore accounts, cryptocurrency income or cannabis income earned before 2022, you should hold off on filing your 2022 taxes and instead file an extension.

An extension is your way of asking the IRS for additional time to file your tax return. The IRS will automatically grant you an additional time to file your return. While State Tax Agencies will also provide the same extension period, you need to check with your State to see if an extension must be filed with the State as well.  For example, California does not require that a State extension be filed as long as you timely file the Federal extension AND you will not owe any money to the State.

The deadline to file your 2022 federal individual income tax returns or request an extension of time to file the tax return is Tuesday, April 18, 2023 (normally would have been April 15th but for the observance of the Emancipation Day holiday in the District of Columbia on the 17th and the 15th falling on a Saturday).  Certain areas in the U.S. that have Federal Disaster Declarations in effect may already be under an extended filing deadline.  A timely filed extension will extend the filing deadline to Monday, October 16, 2023 thus giving you an extra six months to meet with tax counsel and determine how to address your pre-2022 tax reporting delinquencies and/or exposure and how to present your situation on your 2022 tax return.

While an extension gives you extra time to file your return, an extension does not give you extra time to pay your tax and if you do not pay what you owe with the extension, you will still be ultimately charged with late payment penalties when you file your tax return.

Offshore Accounts

Where a taxpayer does not come forward voluntarily though a Voluntary Disclosure Program and has now been targeted by IRS for failing to file the Foreign Bank Account Reports (FBAR), the IRS may now assert FBAR penalties that could be either non-willful or willful.  Both types have varying upper limits, but no floor.  The first type is the non-willful FBAR penalty.  The maximum non-willful FBAR penalty is $10,000.  The second type is the willful FBAR penalty.  The maximum willful FBAR penalty is the greater of (a) $100,000 or (b) 50% of the total balance of the foreign account.  In addition, the IRS can pursue criminal charges with the willful FBAR penalty.  The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

For the non-willful penalty, all the IRS has to show is that an FBAR was not filed.  Whether the taxpayer knew or did not know about the filing of this form is irrelevant.  The non-willful FBAR penalty is $10,000 per year regardless of the number of accounts not reported.

Since 2009, the IRS Criminal Investigation has indicted 1,545 taxpayers on criminal violations related to international activities, of which 671 taxpayers were indicted on international criminal tax violations.

Cryptocurrency

Many taxpayers think that their crypto transactions would remain a secret forever.  Digital exchanges are not broker-regulated by the IRS. Digital exchanges are not obligated to issue a 1099 form, nor are they obligated to report to the IRS calculate gains or cost basis for the trader. But that is now all changing sooner than you think!

As of March 16, 2018, the IRS has received information from Coinbase located in San Francisco which is the largest cryptocurrency exchange in the United States disclosing the names, addresses and tax identification numbers on 14,355 account holders. Coinbase pursuant to a Court Order issued by a Federal Magistrate Judge (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431) had to produce the following customer information over the period of 2013 to 2015: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

Furthermore, Coinbase starting with the 2017 tax years is issuing 1099-K tax forms for some of its U.S. clients.  The IRS will receive copies of these forms.

Following the success of the results of a John Doe Summons issued to Coinbase, Inc. as I previously reported, on April 1, 2021 the U.S. Department Of Justice announced that a federal court in the District of Massachusetts entered an order authorizing the IRS to serve a John Doe summons on Circle Internet Financial Inc., or its predecessors, subsidiaries, divisions, and affiliates, including Poloniex LLC (collectively “Circle”), seeking information about U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020. The IRS is seeking the records of Americans who engaged in business with or through Circle, a digital currency exchanger headquartered in Boston.

With only several hundred people reporting their crypto gains each year, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.

Cannabis

Over 300,000 Americans now work in the legal cannabis industry – these workers were declared “essential” during the COVID emergency. More states are legalizing cannabis where presently the total number of adult-use states is 21 and medical-use states is 37 plus the District of Columbia.  There are also 6 tribal nations and most of the U.S. territories that have legalized cannabis.  With the proliferation of licensed cannabis businesses sprouting across the country, a continued stream of cannabis business will be filing tax returns with the IRS.  But beware, the IRS is well aware that successful cannabis businesses don’t just sprout overnight and now that your business is on the radar screen you can bet that the IRS will be inquiring how you accumulated all that cash before 2022.

Cannabis is categorized as a Schedule I substance under the Controlled Substances Act. While more than half of the states in the U.S. have legalized some form of medicinal marijuana, and several others have passed laws permitting recreational cannabis use, under federal drug laws the sale of cannabis remains illegal.

Despite the disparity and Federal and State law, marijuana businesses still have to pay taxes.

Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.

A cannabis business that has not properly reported its income and expenses and not engaged in the planning to minimize income taxes can face a large liability proposed by IRS reflected on a Notice Of Deficiency or tax bill.  Likewise, where a taxpayer over the years has accumulated cash from cannabis sales and never reported any income to the IRS, you are looking at a serious problem.

Penalties For Filing A False Income Tax Return Or Under-reporting Income 

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS!

What Should You Do?

Individual taxpayers can file an extension using Form 4868. Extensions can also be filed online, which has the benefit that you’ll receive a confirmation code from the IRS notifying you that your extension was received.  Then you should promptly contact tax counsel.  Don’t delay because once the IRS has targeted you for investigation – even if it is a routine random audit – it will be too late voluntarily come forward. Let the tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Los Angeles and offices elsewhere in California get you set up with a plan that may include being qualified into a voluntary disclosure program to avoid criminal prosecution, seek abatement of penalties, and minimize your tax liability. If you are involved in cannabis, check out what else a cannabis tax attorney can do for you. Also, if you are involved in crypto currency, check out what a Bitcoin tax attorney can do for you.

Getting Ready For Tax Season 2023 – What You Need To Know About Reporting Cryptocurrency

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Getting Ready For Tax Season 2023 – What You Need To Know About Reporting Cryptocurrency. 

Cryptocurrency / Bitcoin – Is this the 21st century answer to hiding assets in Swiss bank accounts? 

The IRS thinks this is the case which is why the IRS has stepped up its investigation efforts to uncover non-compliant taxpayers just like the IRS successfully did in its investigation of the Swiss banks leading Congress to enact the Foreign Account Tax Compliance Act (“FATCA”).  FATCA forces foreign banks to disclose information on U.S. account holders which the IRS receives and matches the information reported by U.S. taxpayers.  No longer can taxpayers avoid reporting income on their foreign bank accounts.  No longer can taxpayers avoid disclosing their foreign bank accounts.

With more businesses willing to accept and transact in cryptocurrencies, the absence of specific rules related to the reporting of business income from cryptocurrency transactions has created a “tax gap” that the IRS intends to close.

The IRS now groups cryptocurrency, convertible virtual currency, stablecoins and non-fungible tokens (NFTs) as “digital assets”.

How To Report Cryptocurrency On Your 2022 Income Tax Return. 

The IRS treats cryptocurrencies like property, meaning that anytime you spend, exchange, or sell your cryptocurrency, you create a taxable event. So just like stocks, you would look at how much you paid for your cryptocurrency, which is the cost basis, and the market value at the time you spent it or sales price when you sold it. That difference if disposed at a gain is subject to tax.  If disposed at a loss, that loss can offset your capital gains.  You would report these transactions on Form 8949, Sales And Other Dispositions Of Capital Assets.

In determining the cost basis of the cryptocurrency disposed, you get to pick and choose which cryptocurrency acquisition was the source of the disposition.  To show the smallest gain (or largest loss), you should pick the most expensive acquisition of that cryptocurrency later disposed.  This accounting method is known as “HIFO” accounting.  HIFO stands for “highest in, first out”.   By keeping detailed records of your cryptocurrency transactions and cost basis to employ this method of accounting, a taxpayer should be able to save on taxes.

How IRS Targets Cryptocurrency.

The IRS has one of the most extensive data collections in the world. Traditionally its power to enforce has come through the matching of data. For example, you received a W-2 Form from your employer showing how much you earned. That same form is submitted by your employer to the IRS. Now the IRS can match your return to that form to make sure you are reporting the income. The same thing goes for 1099 forms showing your earnings from miscellaneous income, gambling winnings, interest and dividend income, sales of assets, deductions, and so on.

But with Bitcoin and other cryptocurrencies, there is no such third-party reporting.  Digital exchanges are not broker-regulated by the IRS. Exchanges do not issue a 1099 form, nor do they calculate gains or cost basis for the trader.

On May 20, 2021, U.S. Department Of Treasury released a report that included a set of proposed tax compliance initiatives with the goal of closing the gap between taxes owed and taxes actually paid. These measures are encompassed in the American Families Plan, which establishes rules for the proper reporting of cryptocurrency including a new rule that would require businesses to file a current transaction report when they receive cryptocurrency worth more than $10,000, just as most businesses are required to report cash payments in these amounts.

On August 10, 2021, H.R. 3684, known as the Infrastructure Investment and Jobs Act, was passed by the Senate.  Although this bill has yet to be considered by the House of Representatives, it includes a provision that would require broker reporting of crypto-asset transfers. Section 80603 of the bill imposes new crypto-assets information reporting requirements on brokers. The Sec. 6045(c)(1) definition of “broker” is expanded to include anyone who for consideration effectuates “transfers of digital assets on behalf of another person”.  For these purposes, “digital asset” is defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.”  Furthermore, the bill would amend Sec. 6045A to require brokers to provide information returns reporting any transfers of digital assets to accounts that are not maintained by a broker.

But the IRS does not stop there …

Chainalysis Reactor Software

The IRS and other federal agencies want to catch up on, and make sense of, the worldwide web of bitcoin and other cryptocurrencies.  Chainalysis is a company that created a cryptocurrency-tracing software dubbed “Reactor” which is being used by at least 10 federal agencies including the IRS.  The IRS Cyber Crimes Unit (CCU), a five-year-old division of its larger Criminal Investigation (CI) wing and the leader in the IRS’ cryptocurrency crimes investigations, uses this software as a tool to help identify taxpayers who could be non-compliant in the tax laws or involved in criminal activity.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Cryptocurrency Transactions.

A John Doe Summons issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase will be required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

ON MARCH 16, 2018 COINBASE COMPLIED WITH THIS SUMMONS AND TURNED OVER DATA OF 14,355 ACCOUNT HOLDERS TO IRS.

Now while this net may not pick up taxpayers whose accounts have less than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year from 2013 to 2015, it should be clear that this is the first step for the IRS to crush non-compliance for all taxpayers involved with cryptocurrency just like the IRS was successful in battling taxpayers having undisclosed foreign bank accounts.

10,000 Cryptocurrency Owners Receiving Warning Letters From The IRS

After years of analyzing data from third parties involved in the cryptocurrency exchanges, the IRS announced in a press release on July 26, 2019 that it has started sending letters to cryptocurrency owners advising them to report their cryptocurrency transactions and pay their taxes. More than 10,000 taxpayers have been identified by IRS as being involved in cryptocurrency transactions but who the IRS believes may not have been compliant in reporting these transactions on their tax returns.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

Notices Being Sent To Taxpayers Are The First Step In IRS Enforcement Action

The IRS is using three types of notices to send to more than 10,000 taxpayers by the end of August 2019 – notices 6173, 6174 or 6174-A. All three notices indicate the IRS has information that the taxpayer receiving the notice currently has or has had virtual currency. However, it is Letter 6173 that is most serious as it requires a signature from the recipient under perjury that they are compliant with the U.S. tax code or requiring taxpayers to respond to the IRS and either file delinquent returns for tax years 2013 through 2017 or amend previously filed returns and include the applicable forms or schedules reporting cryptocurrency transactions. If you receive a Letter 6173, it should be a virtual certainty that you will be selected for examination.

If you receive Letter 6173, you should consult with a tax attorney as the submission of a statement signed under penalties of perjury that is false can result in serious consequences including criminal prosecution.

Form 1040 Makes It Harder For U.S. Taxpayers To Avoid Non-compliance Or Claim Ignorance.

On the 2022 Form 1040, you are required to answer the following checkbox question:

At any time during 2022, did you: (a) receive (as a reward, award or payment for property or services); or (b) sell, exchange, gift or otherwise dispose of a digital asset (or a financial interest in a digital asset)?   ◊ Yes            ◊ No

Taxpayers will now be required to check the appropriate box to answer the virtual currency question. This question has been on individual income tax returns starting with 2019; however, the term “digital assets” has replaced “virtual currencies,” a term used in previous years.  This requirement is similar to how the IRS includes questions on Schedule B inquiring whether a taxpayer has foreign bank accounts.

Normally, a taxpayer must check the “yes” box if they:

  • Received digital assets as payment for property or services provided;
  • Transferred digital assets for free (without receiving any consideration) as a bona fide gift;
  • Received digital assets resulting from a reward or award;
  • Received new digital assets resulting from mining, staking and similar activities;
  • Received digital assets resulting from a hard fork (a branching of a cryptocurrency’s blockchain that splits a single cryptocurrency into two);
  • Disposed of digital assets in exchange for property or services;
  • Disposed of a digital asset in exchange or trade for another digital asset;
  • Sold a digital asset; or
  • Otherwise disposed of any other financial interest in a digital asset.

Normally, a taxpayer who merely owned digital assets during 2022 can check the “No” box as long as they did not engage in any transactions involving digital assets during the year. They can also check the “No” box if their activities were limited to one or more of the following:

  • Holding digital assets in a wallet or account;
  • Transferring digital assets from one wallet or account they own or control to another wallet or account they own or control; or
  • Purchasing digital assets using U.S. or other real currency, including through electronic platforms such as PayPal and Venmo.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS! And this is why the IRS is first sending Letter 6173 requiring a signature from the recipient under perjury that the taxpayer is compliant with the U.S. tax code BEFORE the IRS then decides to audit the taxpayer.

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

What Should You Do?

With only several hundred people reporting their crypto gains each year since bitcoin’s launch, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.  And now that like-exchange treatment is prohibited on transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.

Take control of this risk and engage a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Bay Area (San Francisco, San Jose and Walnut Creek) and other California locations.  We can come up with solutions and strategies to these risks and protect you and your business to mitigate criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.

 

Why Taxpayers Involved In Offshore Accounts, Cryptocurrency Or Cannabis Should Be Filing An Extension For Their 2021 Income Tax Returns.

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Why Taxpayers Involved In Offshore Accounts, Cryptocurrency Or Cannabis Should Be Filing An Extension For Their 2021 Income Tax Returns.

If you did not report your offshore accounts, cryptocurrency income or cannabis income earned before 2021, you should hold off on filing your 2021 taxes and instead file an extension.

An extension is your way of asking the IRS for additional time to file your tax return. The IRS will automatically grant you an additional time to file your return. While State Tax Agencies will also provide the same extension period, you need to check with your State to see if an extension must be filed with the State as well.  For example, California does not require that a State extension be filed as long as you timely file the Federal extension AND you will not owe any money to the State.

The deadline to file your 2021 federal individual income tax returns or request an extension of time to file the tax return is Monday, April 18, 2022 (normally would have been April 15th but for the observance of the Emancipation Day holiday in the District of Columbia).  Taxpayers in Maine or Massachusetts have until April 19, 2022, to file their returns due to the observance of the Patriots’ Day holiday in those states. A timely filed extension will extend the filing deadline to Monday, October 17, 2022 thus giving you an extra six months to meet with tax counsel and determine how to address your pre-2021 tax reporting delinquencies and/or exposure and how to present your situation on your 2021 tax return.

While an extension gives you extra time to file your return, an extension does not give you extra time to pay your tax and if you do not pay what you owe with the extension, you will still be ultimately charged with late payment penalties when you file your tax return.

Offshore Accounts

Where a taxpayer does not come forward voluntarily though a Voluntary Disclosure Program and has now been targeted by IRS for failing to file the Foreign Bank Account Reports (FBAR), the IRS may now assert FBAR penalties that could be either non-willful or willful.  Both types have varying upper limits, but no floor.  The first type is the non-willful FBAR penalty.  The maximum non-willful FBAR penalty is $10,000.  The second type is the willful FBAR penalty.  The maximum willful FBAR penalty is the greater of (a) $100,000 or (b) 50% of the total balance of the foreign account.  In addition, the IRS can pursue criminal charges with the willful FBAR penalty.  The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

For the non-willful penalty, all the IRS has to show is that an FBAR was not filed.  Whether the taxpayer knew or did not know about the filing of this form is irrelevant.  The non-willful FBAR penalty is $10,000 per account, per year and so a taxpayer with multiple accounts over multiple years can end up with a huge penalty.

Since 2009, the IRS Criminal Investigation has indicted 1,545 taxpayers on criminal violations related to international activities, of which 671 taxpayers were indicted on international criminal tax violations.

Cryptocurrency

Many taxpayers think that their crypto transactions would remain a secret forever.  Digital exchanges are not broker-regulated by the IRS. Digital exchanges are not obligated to issue a 1099 form, nor are they obligated to report to the IRS calculate gains or cost basis for the trader. But that is now all changing sooner than you think!

As of March 16, 2018, the IRS has received information from Coinbase located in San Francisco which is the largest cryptocurrency exchange in the United States disclosing the names, addresses and tax identification numbers on 14,355 account holders. Coinbase pursuant to a Court Order issued by a Federal Magistrate Judge (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431) had to produce the following customer information over the period of 2013 to 2015: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

Furthermore, Coinbase starting with the 2017 tax years will be issuing 1099-K tax forms for some of its U.S. clients.  The IRS will receive copies of these forms.

Following the success of the results of a John Doe Summons issued to Coinbase, Inc. as I previously reported, on April 1, 2021 the U.S. Department Of Justice announced that a federal court in the District of Massachusetts entered an order today authorizing the IRS to serve a John Doe summons on Circle Internet Financial Inc., or its predecessors, subsidiaries, divisions, and affiliates, including Poloniex LLC (collectively “Circle”), seeking information about U.S. taxpayers who conducted at least the equivalent of $20,000 in transactions in cryptocurrency during the years 2016 to 2020. The IRS is seeking the records of Americans who engaged in business with or through Circle, a digital currency exchanger headquartered in Boston.

With only several hundred people reporting their crypto gains each year, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.

Cannabis

Over 300,000 Americans now work in the legal cannabis industry – these workers were declared “essential” during the COVID emergency. In the past few weeks, three more states have legalized bringing the total number of adult-use states to 18, along with the 37 medical states and the District of Columbia.  There are also 6 tribal nations and most of the U.S. territories that have legalized cannabis.  With the proliferation of licensed cannabis businesses sprouting across the country, a continued stream of cannabis business will be filing tax returns with the IRS.  But beware, the IRS is well aware that successful cannabis businesses don’t just sprout overnight and now that your business is on the radar screen you can bet that the IRS will be inquiring how you accumulated all that cash before 2021.

Cannabis is categorized as a Schedule I substance under the Controlled Substances Act. While more than half of the states in the U.S. have legalized some form of medicinal marijuana, and several others have passed laws permitting recreational cannabis use, under federal drug laws the sale of cannabis remains illegal.

Despite the disparity and Federal and State law, marijuana businesses still have to pay taxes.

Generally, businesses can deduct ordinary and necessary business expenses under I.R.C. §162. This includes wages, rent, supplies, etc. However, in 1982 Congress added I.R.C. §280E. Under §280E, taxpayers cannot deduct any amount for a trade or business where the trade or business consists of trafficking in controlled substances…which is prohibited by Federal law. Marijuana, including medical marijuana, is a controlled substance. What this means is that dispensaries and other businesses trafficking in marijuana have to report all of their income and cannot deduct rent, wages, and other expenses, making their marginal tax rate substantially higher than most other businesses.

A cannabis business that has not properly reported its income and expenses and not engaged in the planning to minimize income taxes can face a large liability proposed by IRS reflected on a Notice Of Deficiency or tax bill.  Likewise, where a taxpayer over the years has accumulated cash from cannabis sales and never reported any income to the IRS, you are looking at a serious problem.

Penalties For Filing A False Income Tax Return Or Under-reporting Income 

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS!

What Should You Do?

Individual taxpayers can file an extension using Form 4868. Extensions can also be filed online, which has the benefit that you’ll receive a confirmation code from the IRS notifying you that your extension was received.  Then you should promptly contact tax counsel.  Don’t delay because once the IRS has targeted you for investigation – even if it is a routine random audit – it will be too late voluntarily come forward. Let the tax attorneys at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Los Angeles and offices elsewhere in California get you set up with a plan that may include being qualified into a voluntary disclosure program to avoid criminal prosecution, seek abatement of penalties, and minimize your tax liability. If you are involved in cannabis, check out what else a cannabis tax attorney can do for you. Also, if you are involved in crypto currency, check out what a Bitcoin tax attorney can do for you.

Tips On Holding Cryptocurrency In An IRA To Defer Taxation

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Tips On Holding Cryptocurrency In An IRA To Defer Taxation

Cryptocurrency was not well known and confusing for the general public to get comfortable with but with innovations in the industry starting in 2017, cryptocurrency is becoming more widely known and accepted as a means to do business. One of those innovations increasing the popularity of cryptocurrency is the introduction of a multi-currency wallet that holds Bitcoin Cash and Bitcoin Core in a non-custodial fashion. The wallet known as the “Bitcoin.com Wallet” allows users to store their private keys themselves which avoids the funds to be held by any third party. Since this wallet which became available in August 2017, it is believed that there are now over 81 million wallet users in 2022.

Taxation Of Cryptocurrency

Although both the general public and the crypto community refer to bitcoin, altcoin, etc. as “virtual currencies”, the IRS in 2014 issued Notice 2014-21 stating that it treats them as property for tax purposes. Therefore, selling, spending and even exchanging crypto for other tokens all likely have capital gain implications. Likewise, receiving it as compensation or by other means will be ordinary income.

Some would think that if bitcoin is property, trades should be tax deferred under the like-kind changes rues of IRC section 1031. Under that theory someone who owned Bitcoin could diversify their holdings into Ethereum or Litecoin, and plausibly tell the IRS it created no tax obligations. Unfortunately, the Tax Cuts & Jobs Act of 2017 does away with that loophole making it clear that “like kind exchanges” which lets people swap an asset for a similar one without triggering a tax obligation are not available for non-real estate assets.

While bitcoin receives most of the attention these days, it is only one of hundreds of cryptocurrencies. Everything discussed with regard to bitcoin taxation applies to all cryptocurrencies.

Here are the basic tax rules on specific cryptocurrency transactions:

  • Trading cryptocurrencies produces capital gains or losses, with the latter being able to offset gains and reduce tax.
  • Exchanging one token for another — for example, using Ethereum to purchase an altcoin — creates a taxable event. The token is treated as being sold, thus generating capital gains or losses.
  • Receiving payments in cryptocurrency in exchange for products or services or as salary is treated as ordinary income at the fair market value of the coin at the time of receipt.
  • Spending cryptocurrency is a tax event and may generate capital gains or losses, which can be short-term or long-term. For example, say you bought one coin for $500. If that coin was then worth $700 and you bought a $700 gift card, there is a $200 taxable gain. Depending on the holding period, it could be a short- or long-term capital gain subject to different rates.
  • Converting a cryptocurrency to U.S. dollars or another currency at a gain is a taxable event, as it is treated as being sold, thus generating capital gains.
  • Air drops are considered ordinary income on the day of the air drop. That value will become the basis of the coin. When it’s sold, exchanged, etc., there will be a capital gain.
  • Mining coins is considered ordinary income equal to the fair market value of the coin the day it was successfully mined.
  • Initial coin offerings do not fall under the IRS’s tax-free treatment for raising capital. Thus, they produce ordinary income to individuals and businesses alike.

So How Do The Rules Apply When Holding Cryptocurrency In An IRA?

IRC section 408(m) generally prohibits the investment of assets of an IRA (and any self-directed qualified plan account) in certain “collectibles” including precious metals; however, there are exceptions for certain coins and bullion.

The U.S. Tax Court reaffirmed the physical possession rule in, McNulty v. Commissioner of Internal Revenue, No. 1377-19 (U.S.T.C. Nov. 18, 2021), and this ruling could have a big impact on some cryptocurrency account holders.

In McNulty, the taxpayers (husband and wife) established a self-directed individual retirement account (IRA) under IRC section 408 and directed assets held in the IRA to invest in a single-member limited liability company (LLC). Mr. McNulty was the manager of the LLC that her IRA invested in. She directed the LLC to purchase American Eagle (AE) coins and took physical possession of the coins. IRS contended that the year she received physical custody of the AE coins resulted in a taxable distribution equal to the cost of the AE coins. The Tax Court agreed with IRS.

The Tax Court stated:

“Independent oversight by a third-party fiduciary to track and monitor investment activities is one of the key aspects of the statutory scheme. When coins or bullion are in the physical possession of the IRA owner (in whatever capacity the owner may be acting), there is no independent oversight that could prevent the owner from invading her retirement funds. This lack of oversight is clearly inconsistent with the statutory scheme. Personal control over the IRA assets by the IRA owner is against the very nature of an IRA.”

The Tax Court’s focus on the “taxpayer’s control” of an IRA asset can have far reaching implications for self-directed IRA’s beyond bullion coins.  In the case of cryptocurrency, holding cryptocurrency in a cold wallet that is controlled by the IRA owner would provide the IRA owner with “unfettered control”.  A cold wallet can be detached from the internet. Hardware wallets and paper wallets are both cold wallet options. Hardware wallets use a physical medium — typically in the shape of a USB stick — to store the wallet’s private keys, making them de facto unreachable to hackers or other malicious parties.

So if you are looking to invest in cryptocurrency through a self-directed IRA, it is best to hold your cryptocurrency on a licensed and insured crypto exchange in the name of the IRA to avoid the impact of the physical possession rule of IRC section 408(m).

IRS Suspicion Of Noncompliant Taxpayers In Cryptocurrency

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

The IRS suspects that many cryptocurrency users have been evading taxes by not reporting crypto transactions on their tax returns given the millions of wallets already issued.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS!

What Should You Do?

Especially now that like-exchange treatment is prohibited on non-real estate transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward. Let a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), San Francisco Bay Area (including San Jose and Walnut Creek) and elsewhere in California get you qualified into a voluntary disclosure program to avoid criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what a cannabis tax attorney can do for you.

Getting Ready For Tax Season 2022 – What You Need To Know About Reporting Cryptocurrency.

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Getting Ready For Tax Season 2022 – What You Need To Know About Reporting Cryptocurrency.

Cryptocurrency / Bitcoin – Is this the 21st century answer to hiding assets in Swiss bank accounts? 

The IRS thinks this is the case which is why the IRS has stepped up its investigation efforts to uncover non-compliant taxpayers just like the IRS successfully did in its investigation of the Swiss banks leading Congress to enact the Foreign Account Tax Compliance Act (“FATCA”).  FATCA forces foreign banks to disclose information on U.S. account holders which the IRS receives and matches the information reported by U.S. taxpayers.  No longer can taxpayers avoid reporting income on their foreign bank accounts.  No longer can taxpayers avoid disclosing their foreign bank accounts.

With more businesses willing to accept and transact in cryptocurrencies, the absence of specific rules related to the reporting of business income from cryptocurrency transactions has created a “tax gap” that the IRS intends to close.

How To Report Cryptocurrency On Your 2021 Income Tax Return.

The IRS treats cryptocurrencies like property, meaning that anytime you spend, exchange, or sell your cryptocurrency, you create a taxable event. So just like stocks, you would look at how much you paid for your cryptocurrency, which is the cost basis, and the market value at the time you spent it or sales price when you sold it. That difference if disposed at a gain is subject to tax.  If disposed at a loss, that loss can offset your capital gains.  You would report these transactions on Form 8949, Sales And Other Dispositions Of Capital Assets.

In determining the cost basis of the cryptocurrency disposed, you get to pick and choose which cryptocurrency acquisition was the source of the disposition.  To show the smallest gain (or largest loss), you should pick the most expensive acquisition of that cryptocurrency later disposed.  This accounting method is known as “HIFO” accounting.  HIFO stands for “highest in, first out”.   By keeping detailed records of your cryptocurrency transactions and cost basis to employ this method of accounting, a taxpayer should be able to save on taxes.

How IRS Targets Cryptocurrency.

The IRS has one of the most extensive data collections in the world. Traditionally its power to enforce has come through the matching of data. For example, you received a W-2 Form from your employer showing how much you earned. That same form is submitted by your employer to the IRS. Now the IRS can match your return to that form to make sure you are reporting the income. The same thing goes for 1099 forms showing your earnings from miscellaneous income, gambling winnings, interest and dividend income, sales of assets, deductions, and so on.

But with Bitcoin and other cryptocurrencies, there is no such third-party reporting.  Digital exchanges are not broker-regulated by the IRS. Exchanges do not issue a 1099 form, nor do they calculate gains or cost basis for the trader.

On May 20, 2021, U.S. Department Of Treasury released a report that included a set of proposed tax compliance initiatives with the goal of closing the gap between taxes owed and taxes actually paid. These measures are encompassed in the American Families Plan, which establishes rules for the proper reporting of cryptocurrency including a new rule that would require businesses to file a current transaction report when they receive cryptocurrency worth more than $10,000, just as most businesses are required to report cash payments in these amounts.

On August 10, 2021, H.R. 3684, known as the Infrastructure Investment and Jobs Act, was passed by the Senate.  Although this bill has yet to be considered by the House of Representatives, it includes a provision that would require broker reporting of crypto-asset transfers. Section 80603 of the bill imposes new crypto-assets information reporting requirements on brokers. The Sec. 6045(c)(1) definition of “broker” is expanded to include anyone who for consideration effectuates “transfers of digital assets on behalf of another person”.  For these purposes, “digital asset” is defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.”  Furthermore, the bill would amend Sec. 6045A to require brokers to provide information returns reporting any transfers of digital assets to accounts that are not maintained by a broker.

But the IRS does not stop there …

Chainalysis Reactor Software

The IRS and other federal agencies want to catch up on, and make sense of, the worldwide web of bitcoin and other cryptocurrencies.  Chainalysis is a company that created a cryptocurrency-tracing software dubbed “Reactor” which is being used by at least 10 federal agencies including the IRS.  The IRS Cyber Crimes Unit (CCU), a five-year-old division of its larger Criminal Investigation (CI) wing and the leader in the IRS’ cryptocurrency crimes investigations, uses this software as a tool to help identify taxpayers who could be non-compliant in the tax laws or involved in criminal activity.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Cryptocurrency Transactions.

A John Doe Summons issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase will be required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

ON MARCH 16, 2018 COINBASE COMPLIED WITH THIS SUMMONS AND TURNED OVER DATA OF 14,355 ACCOUNT HOLDERS TO IRS.

Now while this net may not pick up taxpayers whose accounts have less than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year from 2013 to 2015, it should be clear that this is the first step for the IRS to crush non-compliance for all taxpayers involved with cryptocurrency just like the IRS was successful in battling taxpayers having undisclosed foreign bank accounts.

10,000 Cryptocurrency Owners Receiving Warning Letters From The IRS

After years of analyzing data from third parties involved in the cryptocurrency exchanges, the IRS announced in a press release on July 26, 2019 that it has started sending letters to cryptocurrency owners advising them to report their cryptocurrency transactions and pay their taxes. More than 10,000 taxpayers have been identified by IRS as being involved in cryptocurrency transactions but who the IRS believes may not have been compliant in reporting these transactions on their tax returns.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

Notices Being Sent To Taxpayers Are The First Step In IRS Enforcement Action

The IRS is using three types of notices to send to more than 10,000 taxpayers by the end of August 2019 – notices 6173, 6174 or 6174-A. All three notices indicate the IRS has information that the taxpayer receiving the notice currently has or has had virtual currency. However, it is Letter 6173 that is most serious as it requires a signature from the recipient under perjury that they are compliant with the U.S. tax code or requiring taxpayers to respond to the IRS and either file delinquent returns for tax years 2013 through 2017 or amend previously filed returns and include the applicable forms or schedules reporting cryptocurrency transactions. If you receive a Letter 6173, it should be a virtual certainty that you will be selected for examination.

If you receive Letter 6173, you should consult with a tax attorney as the submission of a statement signed under penalties of perjury that is false can result in serious consequences including criminal prosecution.

Form 1040 Makes It Harder For U.S. Taxpayers To Avoid Non-compliance Or Claim Ignorance.

Since 2019, Form 1040 includes the following checkbox question:

At any time during the year, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?   ◊ Yes            ◊ No

Taxpayers will now be required to check the appropriate box to answer the virtual currency question. This requirement is similar to how the IRS includes questions on Schedule B inquiring whether a taxpayer has foreign bank accounts.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS! And this is why the IRS is first sending Letter 6173 requiring a signature from the recipient under perjury that the taxpayer is compliant with the U.S. tax code BEFORE the IRS then decides to audit the taxpayer.

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

What Should You Do?

With only several hundred people reporting their crypto gains each year since bitcoin’s launch, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.  And now that like-exchange treatment is prohibited on transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.

Take control of this risk and engage a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Bay Area (San Francisco, San Jose and Walnut Creek) and other California locations.  We can come up with solutions and strategies to these risks and protect you and your business to mitigate criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.

Infrastructure Bill Tax Provisions Include Increased Reporting Requirements For Cryptocurrency Transactions

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Infrastructure Bill Tax Provisions Include Increased Reporting Requirements For Cryptocurrency Transactions

Section 80603 of the bill imposes new crypto-assets information reporting requirements on brokers.

Cryptocurrency / Bitcoin – Is this the 21st century answer to hiding assets in Swiss bank accounts? 

The IRS thinks this is the case which is why the IRS has stepped up its investigation efforts to uncover non-compliant taxpayers just like the IRS successfully did in its investigation of the Swiss banks leading Congress to enact the Foreign Account Tax Compliance Act (“FATCA”).  FATCA forces foreign banks to disclose information on U.S. account holders which the IRS receives and matches the information reported by U.S. taxpayers.  No longer can taxpayers avoid reporting income on their foreign bank accounts.  No longer can taxpayers avoid disclosing their foreign bank accounts.

With more businesses willing to accept and transact in cryptocurrencies, the absence of specific rules related to the reporting of business income from cryptocurrency transactions has created a “tax gap” that the IRS intends to close.

The IRS has one of the most extensive data collections in the world. Traditionally its power to enforce has come through the matching of data. For example, you received a W-2 Form from your employer showing how much you earned. That same form is submitted by your employer to the IRS. Now the IRS can match your return to that form to make sure you are reporting the income. The same thing goes for 1099 forms showing your earnings from miscellaneous income, gambling winnings, interest and dividend income, sales of assets, deductions, and so on.

But with Bitcoin and other cryptocurrencies, there was no such third-party reporting.  Digital exchanges were not broker-regulated by the IRS. Exchanges did not issue a 1099 form, nor did they calculate gains or cost basis for the trader… until now.

New Reporting Requirements For Cryptocurrency Transactions

On August 10, 2021, H.R. 3684, known as the Infrastructure Investment and Jobs Act, was passed by the Senate on August 10, 2021 and having passed the House Of Representatives on November 5, 2021 it is headed to President Joe Biden’s desk to be signed into law.  This bill includes a provision that would require broker reporting of crypto-asset transfers.

Section 80603 of the bill imposes new crypto-assets information reporting requirements on brokers.

The Sec. 6045(c)(1) definition of “broker” is expanded to include anyone who for consideration effectuates “transfers of digital assets on behalf of another person”.  For these purposes, “digital asset” is defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.”  Furthermore, the bill would amend Sec. 6045A to require brokers to provide information returns reporting any transfers of digital assets to accounts that are not maintained by a broker.

But the IRS does not stop there …

Chainalysis Reactor Software

The IRS and other federal agencies want to catch up on, and make sense of, the worldwide web of bitcoin and other cryptocurrencies.  Chainalysis is a company that created a cryptocurrency-tracing software dubbed “Reactor” which is being used by at least 10 federal agencies including the IRS.  The IRS Cyber Crimes Unit (CCU), a five-year-old division of its larger Criminal Investigation (CI) wing and the leader in the IRS’ cryptocurrency crimes investigations, uses this software as a tool to help identify taxpayers who could be non-compliant in the tax laws or involved in criminal activity.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Cryptocurrency Transactions.

A John Doe Summons issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase will be required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

ON MARCH 16, 2018 COINBASE COMPLIED WITH THIS SUMMONS AND TURNED OVER DATA OF 14,355 ACCOUNT HOLDERS TO IRS.

Now while this net may not pick up taxpayers whose accounts have less than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year from 2013 to 2015, it should be clear that this is the first step for the IRS to crush non-compliance for all taxpayers involved with cryptocurrency just like the IRS was successful in battling taxpayers having undisclosed foreign bank accounts.

10,000 Cryptocurrency Owners Receiving Warning Letters From The IRS

After years of analyzing data from third parties involved in the cryptocurrency exchanges, the IRS announced in a press release on July 26, 2019 that it has started sending letters to cryptocurrency owners advising them to report their cryptocurrency transactions and pay their taxes. More than 10,000 taxpayers have been identified by IRS as being involved in cryptocurrency transactions but who the IRS believes may not have been compliant in reporting these transactions on their tax returns.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

Notices Being Sent To Taxpayers Are The First Step In IRS Enforcement Action

The IRS is using three types of notices to send to more than 10,000 taxpayers by the end of August 2019 – notices 6173, 6174 or 6174-A. All three notices indicate the IRS has information that the taxpayer receiving the notice currently has or has had virtual currency. However, it is Letter 6173 that is most serious as it requires a signature from the recipient under perjury that they are compliant with the U.S. tax code or requiring taxpayers to respond to the IRS and either file delinquent returns for tax years 2013 through 2017 or amend previously filed returns and include the applicable forms or schedules reporting cryptocurrency transactions. If you receive a Letter 6173, it should be a virtual certainty that you will be selected for examination.

If you receive Letter 6173, you should consult with a tax attorney as the submission of a statement signed under penalties of perjury that is false can result in serious consequences including criminal prosecution.

Form 1040 Makes It Harder For U.S. Taxpayers To Avoid Non-compliance Or Claim Ignorance.

Since 2019, Form 1040 includes the following checkbox question:

At any time during the year, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?   ◊ Yes            ◊ No

Taxpayers will now be required to check the appropriate box to answer the virtual currency question. This requirement is similar to how the IRS includes questions on Schedule B inquiring whether a taxpayer has foreign bank accounts.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS! And this is why the IRS is first sending Letter 6173 requiring a signature from the recipient under perjury that the taxpayer is compliant with the U.S. tax code BEFORE the IRS then decides to audit the taxpayer.

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

What Should You Do?

With only several hundred people reporting their crypto gains each year since bitcoin’s launch, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.  And now that like-exchange treatment is prohibited on transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.

Take control of this risk and engage a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Bay Area (San Francisco, San Jose and Walnut Creek) and other California locations.  We can come up with solutions and strategies to these risks and protect you and your business to mitigate criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.

 

Congress Considering Increased Reporting Requirements For Cryptocurrency Transactions

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Cryptocurrency / Bitcoin – Is this the 21st century answer to hiding assets in Swiss bank accounts? 

The IRS thinks this is the case which is why the IRS has stepped up its investigation efforts to uncover non-compliant taxpayers just like the IRS successfully did in its investigation of the Swiss banks leading Congress to enact the Foreign Account Tax Compliance Act (“FATCA”).  FATCA forces foreign banks to disclose information on U.S. account holders which the IRS receives and matches the information reported by U.S. taxpayers.  No longer can taxpayers avoid reporting income on their foreign bank accounts.  No longer can taxpayers avoid disclosing their foreign bank accounts.

With more businesses willing to accept and transact in cryptocurrencies, the absence of specific rules related to the reporting of business income from cryptocurrency transactions has created a “tax gap” that the IRS intends to close.

The IRS has one of the most extensive data collections in the world. Traditionally its power to enforce has come through the matching of data. For example, you received a W-2 Form from your employer showing how much you earned. That same form is submitted by your employer to the IRS. Now the IRS can match your return to that form to make sure you are reporting the income. The same thing goes for 1099 forms showing your earnings from miscellaneous income, gambling winnings, interest and dividend income, sales of assets, deductions, and so on.

But with Bitcoin and other cryptocurrencies, there is no such third-party reporting.  Digital exchanges are not broker-regulated by the IRS. Exchanges do not issue a 1099 form, nor do they calculate gains or cost basis for the trader.

On May 20, 2021, U.S. Department Of Treasury released a report that included a set of proposed tax compliance initiatives with the goal of closing the gap between taxes owed and taxes actually paid. These measures are encompassed in the American Families Plan, which establishes rules for the proper reporting of cryptocurrency including a new rule that would require businesses to file a current transaction report when they receive cryptocurrency worth more than $10,000, just as most businesses are required to report cash payments in these amounts.

On August 10, 2021, H.R. 3684, known as the Infrastructure Investment and Jobs Act, was passed by the Senate.  Although this bill has yet to be considered by the House of Representatives, it includes a provision that would require broker reporting of crypto-asset transfers. Section 80603 of the bill imposes new crypto-assets information reporting requirements on brokers. The Sec. 6045(c)(1) definition of “broker” is expanded to include anyone who for consideration effectuates “transfers of digital assets on behalf of another person”.  For these purposes, “digital asset” is defined as “any digital representation of value which is recorded on a cryptographically secured distributed ledger or any similar technology.”  Furthermore, the bill would amend Sec. 6045A to require brokers to provide information returns reporting any transfers of digital assets to accounts that are not maintained by a broker.

But the IRS does not stop there …

Chainalysis Reactor Software

The IRS and other federal agencies want to catch up on, and make sense of, the worldwide web of bitcoin and other cryptocurrencies.  Chainalysis is a company that created a cryptocurrency-tracing software dubbed “Reactor” which is being used by at least 10 federal agencies including the IRS.  The IRS Cyber Crimes Unit (CCU), a five-year-old division of its larger Criminal Investigation (CI) wing and the leader in the IRS’ cryptocurrency crimes investigations, uses this software as a tool to help identify taxpayers who could be non-compliant in the tax laws or involved in criminal activity.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Cryptocurrency Transactions.

A John Doe Summons issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase will be required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

ON MARCH 16, 2018 COINBASE COMPLIED WITH THIS SUMMONS AND TURNED OVER DATA OF 14,355 ACCOUNT HOLDERS TO IRS.

Now while this net may not pick up taxpayers whose accounts have less than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year from 2013 to 2015, it should be clear that this is the first step for the IRS to crush non-compliance for all taxpayers involved with cryptocurrency just like the IRS was successful in battling taxpayers having undisclosed foreign bank accounts.

10,000 Cryptocurrency Owners Receiving Warning Letters From The IRS

After years of analyzing data from third parties involved in the cryptocurrency exchanges, the IRS announced in a press release on July 26, 2019 that it has started sending letters to cryptocurrency owners advising them to report their cryptocurrency transactions and pay their taxes. More than 10,000 taxpayers have been identified by IRS as being involved in cryptocurrency transactions but who the IRS believes may not have been compliant in reporting these transactions on their tax returns.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

Notices Being Sent To Taxpayers Are The First Step In IRS Enforcement Action

The IRS is using three types of notices to send to more than 10,000 taxpayers by the end of August 2019 – notices 6173, 6174 or 6174-A. All three notices indicate the IRS has information that the taxpayer receiving the notice currently has or has had virtual currency. However, it is Letter 6173 that is most serious as it requires a signature from the recipient under perjury that they are compliant with the U.S. tax code or requiring taxpayers to respond to the IRS and either file delinquent returns for tax years 2013 through 2017 or amend previously filed returns and include the applicable forms or schedules reporting cryptocurrency transactions. If you receive a Letter 6173, it should be a virtual certainty that you will be selected for examination.

If you receive Letter 6173, you should consult with a tax attorney as the submission of a statement signed under penalties of perjury that is false can result in serious consequences including criminal prosecution.

Form 1040 Makes It Harder For U.S. Taxpayers To Avoid Non-compliance Or Claim Ignorance.

Since 2019, Form 1040 includes the following checkbox question:

At any time during the year, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?   ◊ Yes   ◊ No

Taxpayers will now be required to check the appropriate box to answer the virtual currency question. This requirement is similar to how the IRS includes questions on Schedule B inquiring whether a taxpayer has foreign bank accounts.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS! And this is why the IRS is first sending Letter 6173 requiring a signature from the recipient under perjury that the taxpayer is compliant with the U.S. tax code BEFORE the IRS then decides to audit the taxpayer.

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

What Should You Do?

With only several hundred people reporting their crypto gains each year since bitcoin’s launch, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.  And now that like-exchange treatment is prohibited on transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.

Take control of this risk and engage a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Bay Area (San Francisco, San Jose and Walnut Creek) and other California locations.  We can come up with solutions and strategies to these risks and protect you and your business to mitigate criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.

Even The Federal Government Is Trading Cryptocurrency

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That’s right.  You can become a part of the growing cryptocurrency community by placing a winning bid in a GSA Auction cryptocurrency sale. 

On June 16, 2021 the U.S. General Services Administration (“GSA”) issued a press release announcing the opening of bids on 11 lots of cryptocurrency, totaling 8.93 bitcoins and 150.2 litecoins and with a combined market value of nearly $377,000.  GSA first began auctioning cryptocurrency on behalf of the U.S. government in early 2021 (click here of an example of one of the lots). To date, users of the GSA Auctions platform have successfully bid for a total of 16.99 bitcoins over three auctions that garnered $937,092.

The source of the Federal government’s cryptocurrency stash comes from confiscations of all types of assets from taxpayers who are non-compliant or other parties that have allegedly committed Federal crimes.

Cryptocurrency / Bitcoin – Is this the 21st century answer to hiding assets in Swiss bank accounts? 

The IRS thinks this is the case which is why the IRS has stepped up its investigation efforts to uncover non-compliant taxpayers just like the IRS successfully did in its investigation of the Swiss banks leading Congress to enact the Foreign Account Tax Compliance Act (“FATCA”).  FATCA forces foreign banks to disclose information on U.S. account holders which the IRS receives and matches the information reported by U.S. taxpayers.  No longer can taxpayers avoid reporting income on their foreign bank accounts.  No longer can taxpayers avoid disclosing their foreign bank accounts.

With more businesses willing to accept and transact in cryptocurrencies, the absence of specific rules related to the reporting of business income from cryptocurrency transactions has created a “tax gap” that the IRS intends to close.

The IRS has one of the most extensive data collections in the world. Traditionally its power to enforce has come through the matching of data. For example, you received a W-2 Form from your employer showing how much you earned. That same form is submitted by your employer to the IRS. Now the IRS can match your return to that form to make sure you are reporting the income. The same thing goes for 1099 forms showing your earnings from miscellaneous income, gambling winnings, interest and dividend income, sales of assets, deductions, and so on.

But with Bitcoin and other cryptocurrencies, there is no such third-party reporting.  Digital exchanges are not broker-regulated by the IRS. Exchanges do not issue a 1099 form, nor do they calculate gains or cost basis for the trader.

On May 20, 2021, U.S. Department Of Treasury released a report that included a set of proposed tax compliance initiatives with the goal of closing the gap between taxes owed and taxes actually paid. These measures are encompassed in the American Families Plan, which establishes rules for the proper reporting of cryptocurrency including a new rule that would require businesses to file a current transaction report when they receive cryptocurrency worth more than $10,000, just as most businesses are required to report cash payments in these amounts.

But the IRS does not stop there …

Chainalysis Reactor Software

The IRS and other federal agencies want to catch up on, and make sense of, the worldwide web of bitcoin and other cryptocurrencies.  Chainalysis is a company that created a cryptocurrency-tracing software dubbed “Reactor” which is being used by at least 10 federal agencies including the IRS.  The IRS Cyber Crimes Unit (CCU), a five-year-old division of its larger Criminal Investigation (CI) wing and the leader in the IRS’ cryptocurrency crimes investigations, uses this software as a tool to help identify taxpayers who could be non-compliant in the tax laws or involved in criminal activity.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Cryptocurrency Transactions.

A John Doe Summons issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase will be required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

ON MARCH 16, 2018 COINBASE COMPLIED WITH THIS SUMMONS AND TURNED OVER DATA OF 14,355 ACCOUNT HOLDERS TO IRS.

Now while this net may not pick up taxpayers whose accounts have less than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year from 2013 to 2015, it should be clear that this is the first step for the IRS to crush non-compliance for all taxpayers involved with cryptocurrency just like the IRS was successful in battling taxpayers having undisclosed foreign bank accounts.

10,000 Cryptocurrency Owners Receiving Warning Letters From The IRS

After years of analyzing data from third parties involved in the cryptocurrency exchanges, the IRS announced in a press release on July 26, 2019 that it has started sending letters to cryptocurrency owners advising them to report their cryptocurrency transactions and pay their taxes. More than 10,000 taxpayers have been identified by IRS as being involved in cryptocurrency transactions but who the IRS believes may not have been compliant in reporting these transactions on their tax returns.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

Notices Being Sent To Taxpayers Are The First Step In IRS Enforcement Action

The IRS is using three types of notices to send to more than 10,000 taxpayers by the end of August 2019 – notices 6173, 6174 or 6174-A. All three notices indicate the IRS has information that the taxpayer receiving the notice currently has or has had virtual currency. However, it is Letter 6173 that is most serious as it requires a signature from the recipient under perjury that they are compliant with the U.S. tax code or requiring taxpayers to respond to the IRS and either file delinquent returns for tax years 2013 through 2017 or amend previously filed returns and include the applicable forms or schedules reporting cryptocurrency transactions. If you receive a Letter 6173, it should be a virtual certainty that you will be selected for examination.

If you receive Letter 6173, you should consult with a tax attorney as the submission of a statement signed under penalties of perjury that is false can result in serious consequences including criminal prosecution.

Form 1040 Makes It Harder For U.S. Taxpayers To Avoid Non-compliance Or Claim Ignorance.

Since 2019, Form 1040 includes the following checkbox question:

At any time during the year, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?   ◊ Yes            ◊ No

Taxpayers will now be required to check the appropriate box to answer the virtual currency question. This requirement is similar to how the IRS includes questions on Schedule B inquiring whether a taxpayer has foreign bank accounts.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS! And this is why the IRS is first sending Letter 6173 requiring a signature from the recipient under perjury that the taxpayer is compliant with the U.S. tax code BEFORE the IRS then decides to audit the taxpayer.

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

What Should You Do?

With only several hundred people reporting their crypto gains each year since bitcoin’s launch, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.  And now that like-exchange treatment is prohibited on transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.

Take control of this risk and engage a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), the Bay Area (San Francisco, San Jose and Walnut Creek) and other California locations.  We can come up with solutions and strategies to these risks and protect you and your business to mitigate criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.

 

How The American Families Plan Is Helping IRS Step Up Investigations Of Taxpayers Involved In Cryptocurrency

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How The American Families Plan Is Helping IRS Step Up Investigations Of Taxpayers Involved In Cryptocurrency

Cryptocurrency / Bitcoin – Is this the 21st century answer to hiding assets in Swiss bank accounts? 

The IRS thinks this is the case which is why the IRS has stepped up its investigation efforts to uncover non-compliant taxpayers just like the IRS successfully did in its investigation of the Swiss banks leading Congress to enact the Foreign Account Tax Compliance Act (“FATCA”).  FATCA forces foreign banks to disclose information on U.S. account holders which the IRS receives and matches the information reported by U.S. taxpayers.  No longer can taxpayers avoid reporting income on their foreign bank accounts.  No longer can taxpayers avoid disclosing their foreign bank accounts.

With more businesses willing to accept and transact in cryptocurrencies, the absence of specific rules related to the reporting of business income from cryptocurrency transactions has created a “tax gap” that the IRS intends to close.

The IRS has one of the most extensive data collections in the world. Traditionally its power to enforce has come through the matching of data. For example, you received a W-2 Form from your employer showing how much you earned. That same form is submitted by your employer to the IRS. Now the IRS can match your return to that form to make sure you are reporting the income. The same thing goes for 1099 forms showing your earnings from miscellaneous income, gambling winnings, interest and dividend income, sales of assets, deductions, and so on.

But with Bitcoin and other cryptocurrencies, there is no such third-party reporting.  Digital exchanges are not broker-regulated by the IRS. Exchanges do not issue a 1099 form, nor do they calculate gains or cost basis for the trader.

On May 20, 2021, U.S. Department Of Treasury released a report that included a set of proposed tax compliance initiatives with the goal of closing the gap between taxes owed and taxes actually paid. These measures are encompassed in the American Families Plan, which establishes rules for the proper reporting of cryptocurrency including a new rule that would require businesses to file a current transaction report when they receive cryptocurrency worth more than $10,000, just as most businesses are required to report cash payments in these amounts.

But the IRS does not stop there …

Chainalysis Reactor Software

The IRS and other federal agencies want to catch up on, and make sense of, the worldwide web of bitcoin and other cryptocurrencies.  Chainalysis is a company that created a cryptocurrency-tracing software dubbed “Reactor” which is being used by at least 10 federal agencies including the IRS.  The IRS Cyber Crimes Unit (CCU), a five-year-old division of its larger Criminal Investigation (CI) wing and the leader in the IRS’ cryptocurrency crimes investigations, uses this software as a tool to help identify taxpayers who could be non-compliant in the tax laws or involved in criminal activity.

Virtual currency is an ongoing focus area for IRS Criminal Investigation.

In 2018 the IRS announced a Virtual Currency Compliance Campaign to address tax noncompliance related to the use of virtual currency through outreach and examinations of taxpayers. The IRS will remain actively engaged in addressing non-compliance related to virtual currency transactions through a variety of efforts, ranging from taxpayer education to audits to criminal investigations.

IRS Access To Cryptocurrency Transactions.

A John Doe Summons issued by IRS was ruled enforceable by U.S. Magistrate Judge Jacqueline Scott Corley in November 2017 (United States v. Coinbase, Inc., United States District Court, Northern District Of California, Case No.17-cv-01431).  Coinbase located in San Francisco is the largest cryptocurrency exchange in the United States.  Under the order, Coinbase will be required to turn over the names, addresses and tax identification numbers on 14,355 account holders. The Court has ordered Coinbase to produce the following customer information: (1) taxpayer ID number, (2) name, (3) birth date, (4) address, (5) records of account activity, including transaction logs or other records identifying the date, amount, and type of transaction (purchase/sale/exchange), the post transaction balance, and the names of counterparties to the transaction, and (6) all periodic statements of account or invoices (or the equivalent).

ON MARCH 16, 2018 COINBASE COMPLIED WITH THIS SUMMONS AND TURNED OVER DATA OF 14,355 ACCOUNT HOLDERS TO IRS.

Now while this net may not pick up taxpayers whose accounts have less than $20,000 in any one transaction type (buy, sell, send, or receive) in any one year from 2013 to 2015, it should be clear that this is the first step for the IRS to crush non-compliance for all taxpayers involved with cryptocurrency just like the IRS was successful in battling taxpayers having undisclosed foreign bank accounts.

10,000 Cryptocurrency Owners Receiving Warning Letters From The IRS

After years of analyzing data from third parties involved in the cryptocurrency exchanges, the IRS announced in a press release on July 26, 2019 that it has started sending letters to cryptocurrency owners advising them to report their cryptocurrency transactions and pay their taxes. More than 10,000 taxpayers have been identified by IRS as being involved in cryptocurrency transactions but who the IRS believes may not have been compliant in reporting these transactions on their tax returns.

Taxpayers who do not properly report the income tax consequences of virtual currency transactions are, when appropriate, liable for tax, penalties and interest. In some cases, taxpayers could be subject to criminal prosecution.

Notices Being Sent To Taxpayers Are The First Step In IRS Enforcement Action

The IRS is using three types of notices to send to more than 10,000 taxpayers by the end of August 2019 – notices 6173, 6174 or 6174-A. All three notices indicate the IRS has information that the taxpayer receiving the notice currently has or has had virtual currency. However, it is Letter 6173 that is most serious as it requires a signature from the recipient under perjury that they are compliant with the U.S. tax code or requiring taxpayers to respond to the IRS and either file delinquent returns for tax years 2013 through 2017 or amend previously filed returns and include the applicable forms or schedules reporting cryptocurrency transactions. If you receive a Letter 6173, it should be a virtual certainty that you will be selected for examination.

If you receive Letter 6173, you should consult with a tax attorney as the submission of a statement signed under penalties of perjury that is false can result in serious consequences including criminal prosecution.

Form 1040 Makes It Harder For U.S. Taxpayers To Avoid Non-compliance Or Claim Ignorance.

Since 2019, Form 1040 includes the following checkbox question:

At any time during the year, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?   ◊ Yes            ◊ No

Taxpayers will now be required to check the appropriate box to answer the virtual currency question. This requirement is similar to how the IRS includes questions on Schedule B inquiring whether a taxpayer has foreign bank accounts.

Taxpayers who answer “no” and for who the IRS later determines should have answered “yes” could face civil or criminal penalties and it could affect their success in having penalties abated for reasonable cause.

Penalties For Filing A False Income Tax Return Or Under-reporting Income

Failure to report all the money you make is a main reason folks end up facing an IRS auditor. Carelessness on your tax return might get you whacked with a 20% penalty. But that’s nothing compared to the 75% civil penalty for willful tax fraud and possibly facing criminal charges of tax evasion that if convicted could land you in jail.

Criminal Fraud – The law defines that any person who willfully attempts in any manner to evade or defeat any tax under the Internal Revenue Code or the payment thereof is, in addition to other penalties provided by law, guilty of a felony and, upon conviction thereof, can be fined not more than $100,000 ($500,000 in the case of a corporation), or imprisoned not more than five years, or both, together with the costs of prosecution (Code Sec. 7201).

The term “willfully” has been interpreted to require a specific intent to violate the law (U.S. v. Pomponio, 429 U.S. 10 (1976)). The term “willfulness” is defined as the voluntary, intentional violation of a known legal duty (Cheek v. U.S., 498 U.S. 192 (1991)).

And even if the IRS is not looking to put you in jail, they will be looking to hit you with a big tax bill with hefty penalties.

Civil Fraud – Normally the IRS will impose a negligence penalty of 20% of the underpayment of tax (Code Sec. 6662(b)(1) and 6662(b)(2)) but violations of the Internal Revenue Code with the intent to evade income taxes may result in a civil fraud penalty. In lieu of the 20% negligence penalty, the civil fraud penalty is 75% of the underpayment of tax (Code Sec. 6663). The imposition of the Civil Fraud Penalty essentially doubles your liability to the IRS! And this is why the IRS is first sending Letter 6173 requiring a signature from the recipient under perjury that the taxpayer is compliant with the U.S. tax code BEFORE the IRS then decides to audit the taxpayer.

Voluntary Disclosure – The Way To Avoid Criminal Fines & Punishment

The IRS has not yet announced a specific tax amnesty for people who failed to report their gains and income from Bitcoin and other virtual currencies but under the existing Voluntary Disclosure Program, non-compliant taxpayers can come forward to avoid criminal prosecution and negotiate lower penalties.

What Should You Do?

With only several hundred people reporting their crypto gains each year since bitcoin’s launch, the IRS suspects that many crypto users have been evading taxes by not reporting crypto transactions on their tax returns.  And now that like-exchange treatment is prohibited on transactions that occur after 2017, now is the ideal time to be proactive and come forward with voluntary disclosure to lock in your deferred gains through 2017, eliminate your risk for criminal prosecution, and minimize your civil penalties.  Don’t delay because once the IRS has targeted you for investigation – even it’s is a routine random audit – it will be too late voluntarily come forward.

Take control of this risk and engage a bitcoin tax attorney at the Law Offices Of Jeffrey B. Kahn, P.C. located in Orange County (Irvine), Inland Empire (Ontario and Palm Springs) and other California locations.  We can come up with solutions and strategies to these risks and protect you and your business to mitigate criminal prosecution, seek abatement of penalties, and minimize your tax liability.  Also, if you are involved in cannabis, check out what our cannabis tax attorney can do for you.