Crypto-currency / Bitcoin – Is this the 21^st 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.

But with Bitcoin and other crypto-currencies, 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.

IRS Investigative Action

Given the ability for taxpayers to engage in bitcoin transactions without proper tax reporting, the IRS though has stepped up its investigation efforts to uncover non-compliant taxpayers.

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.

Taxation Of Crypto-currency

Although both the 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 Sec. 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 new 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 crypto 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 crypto 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 crypto 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.

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.

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.

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