How The IRS Plans To Enforce Taxes On Virtual Currency
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Virtual currency is a top priority for the IRS. If you are non-compliant, you must take timely action (NOW!). The IRS is willing to help taxpayers understand their tax obligations concerning virtual currency. According to the IRS, 8-percent of US adults hold some form of cryptocurrency, which means that almost 12 million Americans should have reported some cryptocurrency transactions, but only a fraction of them reported their transactions.
There is more than one way to become tax and reporting compliant if you failed to report or pay tax on your virtual currency transactions. If you received a Virtual Currency Letter, it is imperative that you become tax compliant quickly. It is vital to consult a tax advisor familiar with virtual currency and tax remediation to navigate your compliance options.
File a Delinquent Or Amended Tax Return
|FOR US TAXPAYERS WHO DID NOT COMMIT TAX OR TAX-RELATED CRIMES AND DID NOT WILLFULLY VIOLATE THE LAW TO REPORT OR PAY TAX ON VIRTUAL CURRENCY TRANSACTIONS|
For these taxpayers, the most suitable compliance option is to file delinquent or amended tax returns for the most recent three tax years and any of the past six years n which they omitted at least 25-percent of their gross income.
These filings might be subject to automatic penalties of up to 47.5% in combined failure-to-file and failure-to-pay penalties, and they can subsequently select the taxpayer’s tax returns for examination and assess more penalties.
|FOR US TAXPAYERS WHO WILLFULLY VIOLATED THE LAW TO REPORT OR PAY TAX ON VIRTUAL CURRENCY TRANSACTIONS|
The voluntary disclosure practice provides taxpayers with criminal exposure a way to avoid prosecution and to make good faith arrangements to pay their tax, penalties, and interest fully.
|VIRTUAL CURRENCY ISSUES IS A SPECIAL DISCLOSURE FEATURE THAT TAXPAYERS MUST IDENTIFY AS PART OF THE UPDATED VOLUNTARY DISCLOSURE PRACTICE PRECLEARANCE PROCESS.|
A voluntary disclosure provides no guarantee that a taxpayer will be immune from prosecution, but it will mean that prosecution will not be recommended.
A taxpayer’s voluntary disclosure must be timely, accurate, and complete. It is timely if the IRS Criminal Investigation Division receives it before the IRS:
- Commences a criminal investigation or a civil examination
- Received information from a third party (John Doe summons, whistleblower or other government agency) regarding the taxpayer’s noncompliance
- Acquired information directly related to the taxpayer’s noncompliance from criminal enforcement action (grand jury subpoena, search warrant)
Once the IRS Criminal Investigation Division decides that a taxpayer is eligible to submit a voluntary disclosure, it will be forwarded to an IRS civil examiner.
The disclosure period is typically the taxpayer’s most recent six years of noncompliance and it requires them to submit all of the necessary returns or reports. Over and above ordinarily applicable taxes, penalties (including FBAR), and interest under existing law and procedures, a taxpayer will have to pay a 75% civil fraud penalty based on the tax year with the highest tax liability.
The IRS expects the taxpayer to promptly and fully cooperate during the civil examination AND to fully pay all taxes, penalties and interest for the disclosure period.
Failure to cooperate can result in the IRS Criminal Investigation Division revoking the taxpayer’s preliminary acceptance and extend the civil fraud penalty beyond the ordinary six-year disclosure period.
Certain Non-Wilful Taxpayers: Streamlined Filing Compliance Procedures
Uncertainty remains over US taxpayer’s cryptocurrency-related international reporting requirements. As a result, the IRS Streamlined Filing Compliance Procedures (Procedures) can be another option for individual non-willful taxpayers with foreign-situated virtual currency reporting issues.
The IRS designed the Procedures to address offshore-related noncompliance, eg. For taxpayers who did not report foreign financial assets and pay taxes in respect of these assets because of non-willful conduct.
|NON-WILLFUL CONDUCT IS CONDUCT DRIVEN BY NEGLIGENCE (INCLUDING GROSS NEGLIGENCE), INADVERTENCE OR MISTAKE – or – CONDUCT BASED ON BONA FIDE MISUNDERSTANDING OF THE LAW.|
Procedures are different depending on whether the taxpayer lives in the US or outside the US. A taxpayer must file information returns and tax returns for up to three years, and for FBARs, six years. A taxpayer has to submit a statement of facts – favorable and unfavorable – and certify under penalty of perjury that the noncompliance was a result of non-willful conduct.
The taxpayer must pay all taxes and interest, and for US residents, an offshore penalty equal to 5-percent of the highest aggregate balance or value of foreign assets subject to the offshore penalty.
|Eligibility to submit under the Procedures requires a qualified analysis of the specific facts and circumstances of the case. It remains an atypical option for most taxpayers who failed to report foreign-situated virtual currency transactions.|
Exposition: Virtual Currency Under US Tax Law
For tax purposes, virtual currency is treated as property in the US; therefore, general tax principles that apply to property transactions apply to virtual currency transactions too. The sale or exchange of virtual currency or the use of virtual currency to pay for goods or services has US tax ramifications that create tax liability and information reporting consequences.
|PROPERTY LIKE TRANSACTION-EXAMPLES|
|Creating, investing and trading in virtual currency|
|Using virtual currency as a medium of exchange for goods and services|
|WHAT ARE THE RELEVANT ISSUES RELATED TO THE ABOVE?|
|To identify the units in fair market value, at the cost basis and gain or loss of virtual transactions||Is the transaction taxable or nontaxable?||If it is a taxable event, does it produce capital gain or loss, or ordinary income or loss?||Information reporting requirements?|
|TO ILLUSTRATE THE ABOVE|
|The acquisition or disposition of virtual currency results in a gain or loss that must be reported on a US federal, state or municipal income tax return|
|The character of the gain or loss would depend on whether the virtual currency is a capital asset or an ordinary income transaction|
|Virtual currency wages paid to employees or contractors are taxable to the employee or contractor and implicate information reporting and wage withholding – depending on the status of the recipient.|
IRS Interest In Virtual Currency: A Timeline
|APRIL 14, 2014||NOTICE 2014-21||Defined virtual currency as property|
|NOVEMBER 30, 2016||John Doe Summons||Delivered to Coinbase in San Francisco seeking information about the identity and federal income tax liabilities of US customers of Coinbase for the 2013 to 2015 tax years|
|NOVEMBER 28, 2017||A federal court order||Orders Coinbase to produce documents for accounts with a minimum of $20,000 in any one type of transaction (buy, sell, send or receive) in any year between 2013 and 2015 relating to taxpayer-identification numbers, names, birthdates, addresses and transaction records|
|FEBRUARY 23, 2018||Notification||From Coinbase to 13,000 customers that it would turn over their information to the IRS under the above court order|
|MARCH 23, 2018||IRS News Release||To remind US taxpayers that virtual currency transactions are reportable on US income tax returns|
|That failure to report the above transactions accurately could result in additional tax, interest, penalties and even criminal prosecution|
|JULY 2, 2018||IRS announcement||Of the new Virtual Currency Compliance audit campaign to address taxpayer virtual currency noncompliance. The IRS stated that it WAS NOT contemplating a voluntary disclosure program|
|JULY 26, 2019||IRS announcement||The agency is sending letters to US taxpayers that might have failed to report (properly) virtual currency transactions.|
|Letter 6173||Requests a taxpayer response about alleged noncompliance|
|Letter 6174||For a taxpayer with virtual currency accounts who may not have known about the requirements for reporting|
|Letter 6174-A||For a taxpayer who potentially misreported virtual transactions|
|More than 10,000 letters were sent|
|The IRS also disclosed that it has a list of names of thousands of US taxpayers gained from various compliance efforts|
|OCTOBER 9,2019||IRS guidance||On US federal tax considerations relating to currency transactions by way of frequently asked questions|
|Revenue Ruling 2019-24||Supplements the IRS 2014 notice and provide examples and explanations of how longstanding tax-principles apply to transactions that involve virtual currency and new guidance on how certain transactions like hard forks and airdrops are treated for federal income tax purposes.|
|A hard fork||When a cryptocurrency blockchain is split resulting in two distinct and incompatible versions of the underlying software|
|In this event taxable income does not arise providing any new cryptocurrency is received|
|An airdrop||When cryptocurrency is distributed without payment often, to existing holders or a larger community|
|Taxable income does arise The amount is determined by reference to the fair market value of the cryptocurrency received and the taxpayer’s cost basis|
|OCTOBER 11, 2019||Draft Form 1040 Schedule 1||Taxpayers must respond to a question: “at any time during 2019, did you receive, sell, send, exchange or otherwise acquire any financial interest in any virtual currency?”|
|OCTOBER 22,2019||IRS Alert||IRS Office of Chief Counsel alerted its attorneys to procedures for working and coordinating cases involving virtual currency and other digital asset-related issues.|
|The Chief Counsel noted that virtual currency cases might involve information received from third-party sources and requests for advice from the IRS about federal tax or Bank Secrecy Act audits or matters of litigation|
|NOVEMBER 8, 2019||IRS announcement||IRS Criminal Investigation Division announced the identification of “dozens of leads” and many new investigations of potential cryptocurrency tax evaders after the recent collaborative investigations by Australia, Canada, The Netherlands, the UK, and the US that targeted crimes by large organized networks and individuals|
|NOVEMBER 13, 2019||IRS announcement||Like-kind exchange principles under Section 1031 are not applicable to cryptocurrency, even for transactions before 2018.|
|The IRS however, does not have a blanket policy to deny taxpayers the ability to treat cryptocurrency trades as like-kind exchanges and will instead decide based on taxpayer’s specific facts and circumstances|
|NOVEMBER 15, 2019||FinCEN announcement||It received more than 10,000 suspicious activity reports (SARs) regarding convertible virtual currency|
|Two-thirds of the SARs are from convertible virtual currency entities like kiosks, exchanges, and peer-to-peer exchangers who never filed a SAR advisory before the FinCEN currency advisory in May.|
|NOVEMBER 19,2019||IRS Statement||The IRS cannot provide an answer as to whether a taxpayer must report offshore cryptocurrency holdings on IRS Form 8938, Statement of Specified Foreign Financial Assets.|
|To avoid potential information return reporting penalties, taxpayers should report offshore cryptocurrency holdings on Form 8938|
The IRS can monitor compliance with information reports on virtual currency transactions. It is said that the next big IRS guidance project on virtual currency will focus on developing rules for gross proceeds reporting by brokers under Section 6045. The IRS will also provide further guidance on international information reporting. It is expected that all accounts or wallets held with foreign virtual currency exchanges would become reportable under FBAR provisions shortly.
Taxpayers who are active in virtual currency transactions must maintain detailed and precise records to establish positions on tax returns. They should document receipts, sales, exchanges or other dispositions of virtual currency and the cost basis and fair market value of the virtual currency.
An IRS official stated receipt of a Virtual Currency Letter does not disqualify a taxpayer from entering voluntary disclosure.
Readers should note that this article is only intended to convey general information on these issues and that FAS CPA & Consultants (FAS) in no way intended for the contents of this article to be construed as accounting, business, financial, investment, legal, tax, or other professional advice or services. This article cannot serve as a substitute for such professional services or advice. Any decision or action that may affect the reader’s business should not rely solely on the contents of this article, but should rather be consulted on with a qualified professional adviser. FAS shall not be responsible for any loss sustained by any person who relies on this presentation. This article is subject to change at any time and for any reason.
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