Friday, January 20, 2017

Bitcoin Update | Bethesda Tax Lawyer

Back in June, I wrote this blog about the tax implications of using Bitcoins and other cryptocurrency.  I was also interviewed by VICE, where I discussed the possibility that the IRS might pursue the untaxed money kept in various cryptocurrency accounts (or “wallets,” as users call them).  Over the course of the past three months, the IRS, which has had success recovering revenue from offshore accounts, launched an investigation into the Coinbase “wallet” service to determine the correct amount of tax that people who use virtual currencies such as bitcoin are obligated to pay.  In November, the agency filed a petition to serve a “John Doe” summons, asking for the identities of any US Coinbase customer who transferred crypto-currency with the service between 2013 and 2015.

When signing up to Coinbase, users are sometimes required to provide identification documents. “There is a reasonable basis for believing these US taxpayers failed to comply with internal revenue laws,” the petition continued. In 2014, the IRS stated that virtual currencies which can be converted into fiat currency are property for tax purposes. As noted in an earlier blog, this means, among other things, that wages paid to employees using bitcoin are taxable to the employee, and are subject to federal income tax.

However, the petition acknowledged that not all Coinbase customers may have broken any internal revenue laws: “The taxpayers being investigated have not been or may not be complying with US internal revenue laws requiring the reporting of taxable income from virtual-currency transactions.”

After the petition was filed in November, several individual users rushed to intervene in the case, hoping to quash the “John Doe” summons on privacy grounds.  The IRS responded by arguing that these users, having revealed their identities in order to intervene, were publicly identified and thus unable to claim that the “John Doe” summons threatened their privacy.  The story took a further turn in mid-January, when Brian Armstrong, the CEO of Coinbase, wrote a blog post announcing that his company would fight the summons in court.

Armstrong made several notable points about tax policy, stating that Coinbase was, unlike other cryptocurrency wallets, “committed to compliance” and prepared to issue 1099-B forms at the end of the year to users.  He argued “asking for detailed transaction information on so many people, simply for using digital currency, is a violation of their privacy” and is not a safe and effective path toward tax compliance. He also criticized the current IRS treatment of cryptocurrency as property, noting that this treatment would occasion the distribution of 1099-B forms for even the smallest transactions, since gains on property do not have a de minimis exception.  This could be resolved, he explained, by treating “virtual currency as actual currency for tax purposes” since there is a de minimis exception for actual currency.

It is difficult, though by no means impossible, to contest actions taken by the IRS.  Nevertheless, individuals who have not reported cryptocurrency transactions would be well advised to take steps to voluntarily disclose this unpaid tax instead of awaiting the results of a decision on the “John Doe” summons.  I will cover voluntary disclosure in greater detail in a forthcoming blog, but the following example given by the IRS is worth noting:  a letter from an attorney which encloses amended returns from a client which are complete and accurate (reporting legal source income omitted from the original returns), which offers to pay the tax, interest, and any penalties determined by the IRS to be applicable in full and which meets the timeliness standard set forth above.  This meets the IRS standards for a voluntary disclosure, which consists of a) a taxpayer showing a willingness to cooperate and b) the taxpayer then making a good faith arrangement to pay the IRS in full, along with applicable interest and penalties.  

The IRS has made known its intentions to collect unpaid tax on income currently kept in cryptocurrency accounts.  With that in mind, taxpayers who have untaxed income in these accounts should take affirmative steps to remedy any delinquencies.  I will continue to monitor this litigation as the situation unfolds.

For a free phone consultation regarding Bitcoin, the FBAR, or other tax matters, please contact the Law Office of Aaron P Richter,  a Bethesda-based law firm with expertise in Tax Controversy, Business Formation, Estate Planning, and Tax Preparation.

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