The Internal Revenue Service is continuing to focus on virtual currencies such as bitcoin in its enforcement efforts. In March, the IRS issued a news release reminding taxpayers that income from virtual currencies is reportable on their income tax returns, and that failing to properly report may lead to audits, tax penalties, and in extreme cases even criminal charges for tax evasion or filing a false tax return.
Most recently, on July 2, 2018, the Large Business and International (LB&I) division of the IRS announced five new compliance campaigns, one of which will focus on virtual currency. Compliance campaigns are part of the agency’s transition to issue-based examinations, and they are intended to focus on issues representing a significant risk of noncompliance with tax law in order to make the greatest use of the IRS’s limited enforcement resources. Virtual currency enforcement represents an area of interest because IRS investigations have determined that despite the ever growing popularity of bitcoin, in each year from 2013 through 2015 only 800 to 900 individuals in the U.S. electronically filed a tax return that reported gains from property transactions that were likely related to virtual currency.
The IRS has not released any additional guidance expanding on the tax treatment of bitcoin since it issued Notice 2014-21, which announced that general tax principles applicable to property would also apply to bitcoin transactions. This means that when an individual sells virtual currency, or exchanges it for goods or services, income tax must be paid if the currency has appreciated in value since being acquired. Investors in bitcoin should note that exchanging one virtual currency for another type of virtual currency, converting bitcoin to ethereum for example, is a taxable event. Ensuring proper compliance can pose difficulties for investors, however, because many issues relating to methods for calculation of income from the sale or exchange of virtual currencies have not been addressed by the guidance currently available from the IRS.
Although reporting bitcoin gains may present complex tax issues, the recent announcement of the virtual currency compliance campaign makes proper reporting more urgent for those taxpayers who have income from bitcoin transactions. The IRS stated that the campaign will “address noncompliance related to the use of virtual currency through multiple treatment streams including outreach and examinations. The compliance activities will follow the general tax principles applicable to all transactions in property, as outlined in Notice 2014-21” (1). The IRS also urged taxpayers with unreported virtual currency transactions to correct past returns, but stated that it is not contemplating a voluntary disclosure program specifically directed toward virtual currency.
Individuals who have used the currency exchange Coinbase should be particularly wary of action by the IRS. In November, 2017, the District Court for the Northern District of California ordered Coinbase to produce records associated with accounts with at least $20,000 in any one transaction type (buy, sell, send, or receive) in any year between 2013 and 2015 (2). Those records include the names, addresses, and taxpayer ID numbers associated with the specified accounts, and approximately 14,000 accounts are affected by the court’s order.
(1) Available at: https://www.irs.gov/businesses/irs-announces-the-identification-and-selection-of-five-large-business-and-international-compliance-campaigns
(2) United States v. Coinbase, No. 17-cv-01431-JSC, 2017 U.S. Dist. LEXIS 196306 (N.D. Cal. Nov. 28, 2017).